Financial Strategy

Financial Strategy

Social enterprise is a means to achieve sustainability through earned income; however, it is important to note that financial objectives differ among organizations. Unlike the microfinance field, the financial objective of a social enterprise is not by default viability (generating sufficient income to cover all costs).

Social enterprises don't need to be profitable to be worthwhile. They can improve efficiency and effectiveness of the organization by:

  • reducing the need for donated funds;
  • providing a more reliable, diversified funding base; or
  • enhancing the quality of programs by increasing market discipline. 1

Nonprofit organizations have varying financial motives for incorporating social enterprises into their organizations, ranging from income diversification to full financial self-sufficiency:

  • Income Diversification -- For many nonprofit organizations, social enterprise serves as a strategy to diversify their funding base, decrease reliance on donors, and recover or subsidize program costs. In these cases, the social enterprise offers a means to reduce program deficits and employ resources more efficiently. Organizations seeking means to diversify income may set modest financial objectives. For example, the costs of a program previously 100% grant-funded now covered 40% by earned income is success for many organizations.
  • Financial Self-Sufficiency -- Financial self-sufficiency is achieved by increasing nonprofit organizations' ability to generate sufficient income to cover all or a substantial portion of their costs or fund several social programs without continued reliance on donor funding. Organizations seeking to maximize profit will opt for external subsidiaries expressly for the purpose of funneling money back to the parent organization. Experienced nonprofits may use complex structures and have multiple mixed enterprises and income streams.
  • Cost Savings and Resource Maximization -- This financial objective is usually combined with financial self-sufficiency or income diversification and is concerned with optimizing resources and leveraging assets for economic, social, and community development.
    • Cost savings--is achieved by sharing back office functions, optimizing systems, and streamlining efficiencies to increase business performance and margins.
    • Resource maximization--is achieved through leveraging the nonprofit's financial assets, tangible assets (space, equipment, plant, building, etc.), and intangible assets (proprietary content, methodology, relationships, goodwill, name recognition, skills, and expertise).
  • 1. Dees, Gregory, Enterprising Nonprofits, Harvard Business Review, January-February 1998.

Financial Spectrum of Social Enterprise

Financial Spectrum of Social Enterprise

The level of social enterprise self-sufficiency is based on financial objectives, the type of enterprise, and its maturity. Social enterprise methodology does not dictate breakeven or profit-making; rather, financial performance is appraised by the ability of the social enterprise to achieve the financial objectives it has set.

For this reason, the chart below1 does not represent gradation from one stage of development to the next, unless the social enterprise's express objective is to move across the continuum and performance is a question of maturity.

Organizational Structure Traditional Nonprofit Traditional Nonprofit / Social Enterprise Social Enterprise Social Enterprise Social Enterprise
Financial Spectrum Full Philanthropic Support Partial Self-Sufficiency Cash Flow Self-Sufficiency Operating Self-Sufficiency Financial Self-Sufficiency
Level of income No earned income. Relies on subsidies for financial support to sustain operations. Earned income covers a portion of operating expenses or recovers some program costs. Earned income covers operating expenses of enterprise at lower than market rates. Earned income covers all operating expenses without full market-based costs (capital & investments). Earned income covers all operating and investment expenses at market rate.
Subsidy 100% subsidy. Enterprise and/or parent organization mostly subsidized. Bridges deficit between earned income and expenses, capital investment and growth subsidy. Cost of capital, partial subsidies for loans, and capital expenditures. No subsidies.
Viability through earned income Not viable. Requires continued external financing (grants). Cost recovery is often seen as a side benefit rather than an expectation of the program. Not viable. Organization is dependent on grants and donations for survival; may self-fund isolated services or activities. Approaching viability. Covers direct costs; cost structure and growth subsidized; revenue covers daily operations until breakeven. Viability expected. Operational breakeven; no surplus revenue, subsidies diminish; revenues cover all operating costs. Viable to profitable. Revenues cover all operating and financial costs; retained earnings finance growth. Nonprofit may change its legal status to that of a for-profit entity.
Type of subsidies
  • Philanthropic donations
  • Grants
  • In-kind support
  • Volunteer labor
  • Philanthropic donations
  • Grants
  • In-kind support
  • Volunteer labor
  • Parent organization support
  • Grants to fund deficit
  • Discounts and tax advantages
  • Volunteer or below market labor (interns)
  • Below market interest rates
  • Parent organization support
  • Preferential contracts
  • Discounts and tax advantages
  • Below market interest rates
  • Parent organization support
  • Bridge/gap funds; grants for specific cost costs
  • Preferential contracts
  • Tax benefits allowable by law if organization maintains nonprofit status
  • Preferential contracts
  • 1. Expansion on spectrum idea presented by Gregory Dees, Enterprising Nonprofits, Harvard Business Review, January-February 1998. Adapted from, Alter, Sutia Kim, Managing the Double Bottom Line: A Business Planning Resource Guide for Social Enterprises, Pact Publications, Washington, DC, 2000.

Methods of Income Generation

Methods of Income Generation

Social enterprises use a variety of methods to generate commercial income to sustain operations. At any given time, a social enterprise may use one or a combination of methods, based on the type of enterprise and business strategy.

Method Description Examples
Fee-for-service Charging constituents or clients for social services in order to recover costs of service provision. Museums charge entry fees; microfinance institutions sell financial services; rural clinics collect sliding scale fees for doctor visits.
Products Earned income through manufacturing and product sales, or through mark-up and resale of products. Horticulture cooperative sells flowers wholesale to suppliers; a fair trade company imports cocoa beans and manufactures them into chocolate products to sell in western markets; a handicraft marketing company sells artisan products through a catalogue and takes a commission on sales; a café employing disabled people sells coffee and snacks to the public.
Services Commercialization of a skill or expertise to a market willing and able to pay. Hunger relief organization sells catering services to schools and institutions; children's education organization provides daycare service for a fee; mental health organization sell psychotherapy and counseling services; a national microfinance institution sells management consulting services to other nonprofit organizations interested in starting credit programs.
Membership Dues Fees collected from members of a group, association, or organization in exchange for services such as a newsletter, discounts, conferences, insurance, etc. Dairy subsector trade association provides market information and linkages to its paying members; organization of social enterprise practitioners receives newsletter, listserv, industry reports, job listings, and an annual conference in exchange for an annual fee.
Tangible Assets Generating income by renting or leasing a tangible asset such as office space, building, land, vehicles, or equipment. Human services organization leases its idle office space to another nonprofit organization; a community development organization rents its trucks to a moving company on the weekends; an environmental conservation organization leases its land to an eco-touring organization.
Intangible Assets Generating income by leveraging an intangible asset such as proprietary content, methodology, brand, reputation, relationships, goodwill, etc. International Children's organization licenses its logo and brand name to a clothing line; a university obtains research contracts for scientific study from technology companies; a membership organization sells its mailing list; a youth news agency sells its print content to an online educational service targeting young people.
Investment Dividends Passive income earned from investments. Interest income and dividends from bonds, stocks, savings deposits, and other investments.
Unrelated Business Activities Revenues from a business unrelated to the organization's mission and created for the purpose of funding specific social activities or the organization at-large. Museum shop or retail store of an environmental organization; Girl Scout cookies; a catalogue trinket business supporting a public radio station; nonprofit real estate holdings.

Access to Capital

Access to Capital

Social enterprises, like any other business--micro or corporation, need capital to grow. It's not only a question of financing, but also of the right kind; capital must correspond to social enterprise financial needs, business cycles, and maturity. Furthermore, like any other business, the best make good use of borrowed capital and their own risk capital.

Access to capital, however, is a constraint social enterprises continue to face. The reasons are fourfold:

  • Nonprofit capital markets are immature and underdeveloped, and there is little availability of financial instruments appropriate for capitalizing nonprofit businesses.
  • Ownership and regulatory issues bar nonprofits from access to financing--they cannot issue equity or distribute profits.
  • Nonprofit managers are financially risk adverse and hence often steer clear of options to leverage or borrow funds in order to capitalize their enterprises.
  • For the nonprofit manager willing to borrow, the lack of collateral, credit history, or financial competence are other factors that prohibit access.

Market Maturity

Market maturity and limited available resources present significant problems. Agencies such as the Inter-American Development Bank and social investors such as Calvert Foundation or Partners for the Common Good have worked to fill funding gaps with low interest loans and innovative financing programs, such as SEP.

On the other hand, few donors have come to the table to fund start-up or early stage social enterprise with grants. In cases where donors have funded social enterprises, the philanthropic funding cycle is typically slower than the social enterprises' business cycle (production and sales cycle), which can further challenge capitalization.

To exacerbate matters, there is the worrisome misconception that once an organization has launched a social enterprise, it no longer needs grants for social programs, when in fact early capitalization of the enterprise dictates the opposite. There is also the misperception that social enterprises only need loans. Capitalizing a nonprofit social enterprise may take four or five times longer than its private sector counterpart, due to the social costs and encumbrances of supporting dual objectives. These financial limitations hinder efforts of many social enterprises to take their activities beyond the start-up stage and to stabilize, expand, and diversify. 1

Funding Instruments

Appropriate funding instruments and greater awareness of capitalization issues is needed to facilitate the growth of the social enterprise field as a viable sustainability strategy for nonprofits. Assisting the development of social enterprises' capital markets is a role that onors, philanthropists, and local governments can play. The following exhibit shows the range of funding across the nonprofit and for-profit spectrum. Many of the same funders support both traditional nonprofit and hybrid nonprofit enterprises; however, greater participation and diversity of funding instruments are needed in the latter if this field is to emerge as a mainstay of international development.

Funding Spectrum2

Type of Organization Traditional Nonprofit Social Enterprises Socially Responsible Companies For-Profit
Capital Grants and donations Mix of grants and below market capital No interest or low- interest loans Market rate capital (including social responsible investments) Market rate capital
Sources of Capital and Investors
  • Foundations and government grant programs
  • Multilaterals
  • Bilaterals
  • Individuals

  • Foundations
  • Local government
  • Community Development Financial Institutions
  • Program related investments (PRIs)
  • Bilateral and multilateral lenders
  • Nonprofit social investors
  • Individuals

  • Socially screened funds
  • Shareholder activism
  • Socially screened and traditional venture capitalists
  • Investment banks
  • Individual investors
  • Traditional venture capitalists
  • Investment banks
  • Other investment assets
  • Individual investors
  • Stock
Investment Objective High social return--no expected financial return High social return with below market or no financial return Market rate of financial return and some social return Full market rate of financial return and no expected social return
  • 1. Etchart, Nicole and Lee Davis, Unique and Universal: Lessons from the Emerging Field of Social Enterprise in the Emerging Market Countries, NESsT, 2003.
  • 2. Adapted from Emerson, Jed and Sheila Bonni, The Blended Value Map: Tracking the Intersects and Opportunities of Economic, Social and Environmental Value Creation, September, 2003, www.hewlett.org

External Financing vs. Revenues Over Time

External Financing vs. Revenues Over Time
External Financing vs. Revenues Over Time
Legend: SE = Social Enterprise; Y Axis = Money; X Axis = Time;
External Financing = all financing (grants, loans, contributions) minus revenues (internal financing)

Total expenses can be divided into three subcategories (moving upward along the Y-axis):

  • SE Business Expenses include all costs found in similar businesses that are strictly for-profit, with no consideration for social impact and mission.
  • SE Social Expenses comprise additional expenses incurred because of the social focus of the SE, such as special workplace or benefits requirements. Together, the SE Business Expenses and the SE Social Expenses total the total SE expenses.
  • Program Expenses, in this context, represent expenses incurred to support social programs outside the SE.

From Time 0 to Time A (moving along the X-axis), the SE goes through a start-up phase requiring a lot of external financing. Expenses increase faster than revenues. This is a critical phase during which decision-makers must carefully weigh business expenses based on their potential for generating future revenues.

From Time A to Time B, the SE goes through a growth phase during which external financing is still required, but revenues grow at a faster pace than expenses, leading the way to traditional financial sustainability.

The SE reaches its first breakeven point in Time B, at which point the SE becomes sustainable as a traditional business (a business that does not incur additional social expenses). The difference between all Business Expenses and Revenues between Time 0 and Time B represent the total business investment over that period of time (light gray area on the chart). Even the best management team implementing the best business model cannot succeed in bringing a business to that critical point if decision-makers fail to recognize (and budget) the level of external financing that will be required over that certain period of time, both of which can vary greatly based on a variety of factors (all of which are considered during the business planning phase).

From Time B to Time C, the SE still requires external financing, but only to cover part of its Social Expenses (part of which is also covered by SE Revenues). Depending on the model, some social enterprises never grow beyond that point, in which case they serve in a context in which both SE Revenues and external social subsidies can be effectively leveraged to create social impact.

In Time C, the SE might be reaching a second breakeven point, at which all SE expenses are covered by revenues. Additional SE revenues now generate a profit that can fund social programs outside of the SE.