Which type of funding is right for you? An important decision for social entrepreneurs
Social entrepreneurs, especially those of you with a brilliant idea ready to go, will likely soon wonder where to find the money to pay for it. Choosing the type of funding is one of the most important decisions you will ever make. When attending the 2016 Sankalp Summit in Jakarta (link), I found that there were three types of funding most often being discussed: debt, equity, and grants. So let’s take a closer look at each of them and discuss which one might be right for you.
First is debt: an amount of money borrowed by one party from another under the condition that it is to be paid back at a later date. It is usually lent with interest charged at varying rates. One organization offering debt financing is the Overseas Private Investment Corporation (OPIC) (https://www.opic.gov), on of the U.S. Government’s development finance institutions. During the panel discussion, ‘Innovating Debt Financing Instruments, the OPIC Director of Social Enterprise Finance for Small and Medium Enterprises, Dia Martin, said there are debt finance opportunities, starting with a minimum of US$1 million, for small businesses in Indonesia which are not eligible for private sector financing. Normally more than 50% of the venture must be held by the private sector, with involvement of a U.S. citizen or business.
Next is equity: a stock or share representing ownership of a company. This can be both publicly traded (the investor buys shares through a stock exchange) or private (shareholders invest cash in the business). One equity opportunity was introduced by Aavishkar, an India based social venture capital firm. The Senior Investment Manager, Adi Sudewa, said Aavishkar invests in early stage businesses, starting from US$500,000. Aavishkar does not receive dividends (a portion of the company’s earnings distributed to shareholders), instead waiting for capital gain (profit from the sale of the investment) after around 3-4 years. Many social entrepreneurs dream of partnering with benevolent or angel investors.
Last is grant funding: a gift or subsidy provided by a government or similar organization to an eligible recipient such as an organisation or a person for a special purpose. The U.S. government overseas aid agency, USAID, provides grants to both nonprofit and for-profit organizations. The Development Innovation Ventures (DIV) portfolio (https://www.usaid.gov/div/apply) provides grants to for-profit enterprises, for example Biolite’s cookstoves project in India. DIV’s Chief of the Discover and Test Division, Anne Healy, explained that only 3% of all applications for grants are successful. There is no deadline for applications, and there are at least three aspects that need to be addressed in a proposal: the social impact of the business, cost effectiveness, and pathways to scale.
Now, which type of funding should you choose? Well, each is unique. The benefit of debt is that the lender has little or no control over the business. Once the loan is paid, the relationship with the creditors end. The interest paid is also tax deductible. Also, it can be simply forecasted. However, it is very dependant on the business’ ability to pay back. If the company does not grow as expected, paying the regular schedule could be difficult. Equity has a big advantage in that the investors take (almost) all the risk of the business failing. And usually we do not have to pay the money back. However, the strings attached are often greater. The entrepreneurs will have to give the investor a percentage ownership of the company, also share any profits and involve the partner in decisions affecting the business. The last one is grants. Some may see grants as free money, but grant applications are very competitive, the funds are often restricted and only last for a limited period. The funder usually considers the prospective grantee’s plan around business sustainability issues and many are only available for organizations registered as non-profits.
Many businesses start small by borrowing money from friends and family and then proceed to one of the three options described above. Which type of funding is right for you depends on your idea and your business, the stage in development and your access to resources. Let us know your thoughts and why you chose one type of funding over another. All the best with your quest to find the right funding for your great idea.