Venture Deli

blog

‘Play it safe enterprises’ are weakening dealflow for impact investors

In 2010, the Social Finance Survey found that one in three Canadian charities was considering launching a social enterprise in the following two years. Well, two years on, it would seem that nearly every charity in the country is still considering it.

The problem is that many charities are dipping their toes into social enterprises by launching those that appear less risky, when in reality they are not. Too many charities are considering launching brick and mortar businesses like landscaping, cafes, consulting to limited markets, workshops, and other business models that seem close to their current competencies. Not only is this a suboptimal investment of resources, in aggregate, this thinking is hurting the quality of the ‘pipeline’ of investment opportunities for Canadian impact investors. What’s more, this approach risks placing social enterprise in a crowded bucket of other investment ideas labelled ‘good in theory’.

Low risk enterprises are a myth and are actually riskier in some cases to pursue. People and organizations launching social enterprises would do themselves a favour by being more ambitious. Here’s why:

9 out of 10 businesses fail in their first year

Untrue. So untrue, in fact, as to be near opposite to reality. Industry Canada’s report (http://www NULL.ic NULL.gc NULL.ca/eic/site/061 NULL.nsf/eng/02717 NULL.html) on small businesses shows that 85% survive their first year, and 51% survive five years. Yet we keep terrifying would-be social enterprises with this myth, and trigger their instinct for loss aversion (http://en NULL.wikipedia NULL.org/wiki/Loss_aversion). No wonder charitable boards and managers try to cut anything too unfamiliar or ambitious out of the business plan.

Growing is more important than surviving

But investment is about growth, not survival. Angel investors have to assume they’ll lose money on some deals, which they’ll more than make up for with a few successes. In order to fit that dynamic, each deal needs to have high growth potential, not slow, middle of the road return potential. Of course, there are funders who focus more on low-risk, low-return investments, but they are likely not angel investors. This is an issue, because angels – driven by progressive world views or emotional affiliations – are among the most interested type of investors in social enterprise. Yet they aren’t finding what they’re looking for, so their capital isn’t moving much.

Most small businesses survive year one, but less than 5% are high growth businesses (http://www NULL.ic NULL.gc NULL.ca/eic/site/061 NULL.nsf/eng/02718 NULL.html), as measured by employment growth. This elite group is far more likely to garner angel investment, and tends to include businesses that are focused on research and development. Yet I have come across very few charity-founded social enterprises that are shaped in this mould. In my experience, the majority are developing simple business models with few competitive advantages and no real ambition to be high-growth businesses. Instead, since a common driving cause for considering social enterprises is filling a funding gap, they are too often conceived entirely as preservation of capital schemes, originating from the very loss aversion mentality that relegates growth to a secondary concern. This leads to a lack of imagination, and a fear of ambitious ideas.

Every business that isn’t growing is dying

It may be true that we fetishize scale, but there’s a reason: a business that isn’t growing is dying. There’s no such thing as equilibrium; staying the same is not sustainable in the long run. Inflation grows, competitors strengthen, rent prices go up, and bodies age. Likewise, you can’t grow forever, but that doesn’t matter so long as you’re growing.

It is therefore imperative that social enterprises are designed with scaling in mind. Launching one without a real vision for growth consumes as much blood, sweat and treasure as launching anything else, except without the proportionate reward potential.

So what should charities considering social enterprises do?

Big costs as much as small

If ambitious companies took more effort to run, then you would expect that CEOs of large companies would work many times as much as owners of corner stores. In practice, they work the same and probably experience similar stress levels.

Ambitious enterprises take the same amount of work to build as small ones do, and have the same risk of failure, except with dramatically more upside for those who get it right. Thinking big is the optimal response to the risk of failure present in any enterprise.

Focus on technology based products

Products and services that are born and delivered digitally are far more scalable because there’s much less (in some cases zero) cost to servicing each additional customer, regardless of geography. Moreover, software is quickly becoming better and better at performing operations whose complexity only humans could navigate in the past. This means that at some point, in whatever sector you’re servicing, technology is likely to disrupt how that service is conceived, delivered, and priced. Better to be the cause of the wave than in its path.

Fail fast and iterate

The entrepreneurial world is abuzz with the virtues of failure these days. The reason for this is that virtually no business is exactly correct out of the gate on what its customers want, how, at what price, and even who its customers are. In this context, failing fast is defined not as total business failure, but as learning which assumptions are wrong as quickly as possible, and reinvesting in fixing them quickly. The unit of progress in a new business is not profit, it is the number of assumptions you validate, and how quickly you do that.

This problem will not be solved by a year-long business planning or feasibility process. I have learned this lesson first hand. The only way to validate that you’re creating something people want is by trying to sell it, or a scaled down version of it to them.

2 thoughts on “‘Play it safe enterprises’ are weakening dealflow for impact investors

  1. Keith Loo (http://www NULL.keithloo NULL.com) on said:

    Good article. As an active member of a national charity, my question is this: what would you suggest, as an alternative to B&M business, for a charity to launch?

    The challenge that charities face is a scarcity of resources – and thus many elect to launch enterprises that are familiar, and which may (appear to at least) cost less.

    I think many charities are open to more ambitious, non-traditional businesses if the right opportunities present themselves. The challenge is finding said opportunity.

    (Big fan of Venture Deli – keep up the great work)

    Cheers,

    Keith

  2. venturedeli on said:

    Hi Keith,

    The difference may be imagination. The city of Toronto spent $10M to support artists and performers last year. Kickstarter funnelled about $300M to artists and makers. Etsy funnelled about $500M to artists and artisans.

    It’s not that B&M business are altogether bad, it’s that there is likely a digital (read: more scalable) means for achieving the intended outcome of the charity. At least it’s worth a try from the perspective of failing fast (read: more cheaply), or succeeding at scale.

Leave a Reply

Your email address will not be published. Required fields are marked *

*

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>