Guidance note: Access to Finance

Access to finance has been identified as a key policy lever in building ecosystems for social enterprises by the European Economic and Social Committee, the OECD, and the European Commission’s Expert Group on Social Entrepreneurship (GECES). This guidance note considers the issue of financing social enterprises (rather than buying services from social enterprises, which is covered in the action area on access to markets).

Social enterprises are entities that primarily pursue a social mission, while operating in the market. To start-up, operate and scale-up they seek financing from diverse providers, including public sector, philanthropic foundations, impact investors, as well as mainstream financial institutions. However, social enterprises often face barriers in this process. For instance, they may not meet all the predefined funding criteria set by mainstream finance providers. There is also a common lack of understanding and knowledge among finance providers regarding the risks and returns associated with investing in social enterprises. Therefore, few external funders may be prepared to bet on them.

To access finance, social enterprises often need strengthened capacity to become more financially selfsustainable and less reliant on public and private grants. This implies the need to develop appropriate skills to build sustainable (and scalable) business models and attract investment. Many social enterprises depend on so-called “boot-strapping” techniques, often finding it difficult to scale-up. Increased access to finance can help resolve some of these bottlenecks and make sure that social enterprises can realise their full potential. To deal with both potential finance providers and investees, this document considers the topic of access to finance from the perspective of the demand and supply sides.

For the demand side,  social enterprises need to become increasingly investment ready and develop their capacity to better communicate with potential funders and finance providers. Social enterprises continue to play an important role as suppliers of services or goods to the public sector, and thus tend to be recipients of subsidies, for example when employing people from disadvantaged pgroups. However, the role of social enterprises as “investees” is a relatively more recent phenomenon. As investees, social enterprises are expected to produce a social return on investment, and often also a financial return.

For the supply side, there often tends to be insufficient supply of private funding, partly due to a lack of visibility and understanding of social enterprises among mainstream finance providers. There is also a certain narrow-mindedness and engrained risk-return attitude among many investors. These issues are further compounded by regulatory hurdles and lack of incentives associated with investing in social enterprises. The amount of financing that most social enterprises need is relatively small due to their size, which means that financial intermediaries incur high transaction costs in relation to the size of funding provided and the projected financial return. In addition, exit scenarios are often missing, as it is difficult for social enterprises to return investments according to standard business rates and timeframes, at least at the level of capital repayment. While financing needs vary according to the stages of development of social enterprises, opportunities to meet their needs also differ between countries. With this in mind, it is important to take into account the role of the public sector in terms of: (i) purchasing services from social enterprises, and; (ii) acting as an investor in social innovation by financing social enterprises that experiment with new solutions that can be replicated and scaled; (iii) developing de-risk mechanisms (e.g. guarantee schemes) to facilitate social enterprises’ access to mainstream finance.

In a nutshell, the demand side needs to be supported in order to create more investment ready social enterprises, while the supply side needs more well-informed investors and support for the development of intermediaries, investment incentives and better regulation for investors. There is also need to design co-funding schemes with public financial resources and to support intermediaries that can help broker the relationship between finance providers and social enterprises and build their capacity

Policy Levers for Access to Finance:

• Support the creation and development of intermediaries that can help strengthen the capacity of, and availability of finance for, social enterprises.
• Encourage the participation of mainstream finance providers and social investors in financing for social enterprises, by providing incentives and alleviating regulatory barriers to investment and
• Leverage scarce public funding by using it to de-risk private funding and develop hybrid mechanisms that blend public and private investment.

Pitfalls to Avoid

• Avoid focusing on increasing supply of finance without taking into account the investmentreadiness social enterprises (i.e. the demand side). Actions need to consider both sides, otherwise they may be counter-productive.
• In less mature markets, avoid replicating the latest innovations in more mature markets without having a similar ecosystem in place. Instead, consider the various components needed to build up the capacity of all actors.

Guidance per assessment statement

Why is it important?

The financing needs of social enterprises are different depending on their type of organisation (e.g. nonprofit, cooperative or for-profit limited liability company) and stage of development (e.g. start-up or scale-up phase). To satisfy these different needs, consideration must be given to the maturity of the market, availability of specialised investors in the territory, and the willingness of mainstream funders to support social enterprises.

A first step for the development of tailored policy actions should therefore be to map the financing market at national, regional and local levels. Such a mapping exercise would make sure that policies developed are appropriate and make sense for the specific context. A mapping exercise could include identifying the funding needs of social enterprises, as well as identifying and assessing the activities of main funders, intermediaries and investors. The end result would be to have a clear idea of the market gaps and the most pressing needs that call for policy action.

In order to score high, in your context:

• The financing needs of social enterprises have been assessed.
• The main actors providing funds to social enterprises have been identified.
• The main types of financial intermediaries have been identified.

Why is it important?

In order to score high, in your context:

• Grants and other subsidies are available.
• Debt financing is available.
• Quasi-equity or mezzanine finance is available. (cloud: a high-risk loan, repayment of which depends on the financial success of the social enterprise, for example through royalties based on the future sales of a product or service)
• Quasi-equity or mezzanine finance is available.
• Equity financing is available.
• Innovative hybrid financing instruments that combine grants, debt, quasi-equity and equity are available.¹

_{¹ For explanations of financial terms, see the glossary in the assessment part of the Better Entrepreneurship Policy Tool: www.betterentrepreneurship.eu}

Why is it important?

Social enterprises might lack the capacity or knowledge to find, attract and communicate with funders. Capacity building needs are thus often closely linked to funding. At the pre- start-up and start-up stage, the social enterprise may need skills and experience associated with accessing and utilising different types of funding, or the skills to become financially self-sustainable. At an early growth stage, social enterprises often need assistance to professionalise their processes and functions. At a later growth stage, social enterprises may benefit from support to create investment-ready business models in order to scale their impact. Specialised service providers and intermediaries can be instrumental in this regard, matching the needs of social enterprises with specific skills development programmes and available funds.

In less mature markets, policy makers can support the emergence of specialised service providers that cater to the needs of social enterprises. In more mature markets, investment-readiness programmes can be set up directly by existing specialised service providers to help social enterprises become investment ready. Public agencies can contribute to the development of this part of the ecosystem. For instance, they could identify and provide a list of pre-approved specialised service providers that social enterprises can call upon for high quality support, and which are potentially within their reach in terms of costs, since the services provided by specialised providers tend to be expensive. Financial support (e.g. a grant or a voucher) that allows social enterprises to access such services at a subsidised price (or without cost) may also be warranted.

In order to score high, in your context:

• Specialised services providers help social enterprises to develop the capacity to find, attract, and communicate with funders.
• These services are affordable.
• If these services are expensive, financing support is available to social enterprises for accessing them.

Why is it important?

Specialised private funders (e.g. venture philanthropists, impact investors, ethical investors, social crowdfunding platforms, etc.) can act as catalysts for boosting the social enterprise financing market in various ways. For instance, they can introduce innovative financing instruments that combine grants, debt and equity. They can also mobilise resources and de-risk mainstream financing in order to make it accessible to social enterprises. In addition, specialised private funders can increase the attractiveness of social enterprise financing by highlighting success stories and convening key stakeholders in events to support social enterprises. Yet, specialised private funders that actively target social enterprises as an investment opportunity are still limited in number, especially in less mature markets. In addition, they often struggle themselves in a resource-scarce environment. Therefore, policy-makers can consider leveraging public funds to support the development and growth of specialised private funders.

In order to score high, in your context:

• Specialised private funders are actively targeting social enterprises as an investment opportunity.
• Public funding is used to incentivise specialised funders to actively finance social enterprises.

Why is it important?

Public funding in this context, referring to finance rather than procurement of products or services from social enterprises (covered in the guidance note on access to markets), is often difficult to channel directly to social enterprises for different reasons. One is that policy officers that administer public funds may not always perceive social enterprises as an eligible funding option. They may also lack the competence, skills, and relevant networks to engage directly in social enterprise financing. Therefore, to enable public funding for social enterprises, such as through project grants and financing schemes that combine grants, loans, guarantees and other financial instruments, there is need to build capacity and implement change at all levels of government.

Policy-makers should also consider how they can best support specialised intermediaries who have already developed the required expertise to finance social enterprises, including through funds, project grants, guarantee schemes that de-risk private financing, and hybrid schemes supporting social enterprise development. Subsidies and public investment can also be used to encourage the creation of seed funds that focus on social enterprise development and on social impact investment funds with a patient capital approach. A variety of EU funds and programmes can be actively used in this context (see the good practice example below).

In order to score high, in your context:

• Social enterprises benefit from public grants supporting specific projects.
• Publicly supported financing schemes that combine grants, loans, guarantees and other financial instruments are in place.
• Financial intermediaries benefit from public guarantee schemes to provide funding to social enterprises.