Why good is not great in Social Enterprise, and how to fix it

I was having a drink with a friend recently, who has been leading one of the most well-known impact investment funds in this region. He remarked that this space (Social Enterprise and Impact Investing) is a “bubble”, one which will take a little longer than traditional bubbles to deflate, because of all the structural issues (some of which I will outline below). The word bubble is not the most elegant one to use here – finance types like to use it for asset prices, and get uncomfortable when it is used to define the state of a rather unusual industry. For the sake of greater clarity or even accuracy, I will state that Social Enterprise might be “over-hyped” – it is in the midst of a marketing and communication bubble. But my overall perspective is that regardless of the over-hype, this space is a very important piece of the overall development puzzle, and that we need to shift towards greater rigor across leadership in this industry to help ensure that it does not “deflate”.

From Bill Easterly to Jacqueline Novogratz, the leaders who created this space will tell you that Social Enterprise is an unequivocal improvement on traditional aid and philanthropy. Whether they describe it as “bottom-up development”, “market-driven development”, “searchers succeed while planners fail” or “a new approach to development, combining business & philanthropy”, what is clear is that they see this as a distinct new approach – one that is superior to more traditional approaches with the same fundamental development or poverty eradication goals. Now, charismatic, path breaking leaders often need to hold extreme views in order to get noticed – Bill Easterly would not have sold thousands of books if his views were balanced. And as bland as this might sound, I will go ahead and state that they are all right to some extent – each approach has its place depending on the situation or context, and we need a combination of many approaches across the overall development sector.

But what I have found to be true in my work on the ground here in Kenya is that the two approaches or spaces are remarkably similar – and that many of the criticisms applied to traditional aid and philanthropy can in fact be extended to this space (Social Enterprise or Impact Investing). The following phrase might be interestingly paradoxical, and summarize my key thoughts:

When you’re doing good, it’s hard to do great

First of all, the economics of an impact investment fund are extremely challenging. The deal ticket sizes are quite  small (around USD 1 million on average), and with heavy internal deal team and professional services expenses required on each and every deal (from the accounting due diligence to commercial due diligence to the drafting of lengthy legal documentation), these funds typically end up costing at least 15% of their Assets Under Management (several times a traditional PE or VC fund – a cost base which is too high to cover across any investment asset class, let alone risky young social enterprises) –  and this is just to maintain a steady mid-sized portfolio (I won’t list any hard facts here: the Acumen Fund and Grassroots Business Fund Annual Reports are available on their websites, and list specific figures; also I won’t share any specific stories or anecdotes about deal team associates flying half-way around the world five times over the course of a four month deal, or staying at the fanciest hotels).

None of these funds have reached serious scale (barring one or two which are tapping into Private Banking channels for funding, and are a little more commercial in nature) – this is unlike a traditional service business which, if successful, can be scaled exponentially by focusing on growing and training its talent base. Most of these funds have had stagnant and relatively insignificant deal flows, never more than a few million dollars a year – “a drop in the ocean”, if I might describe them as such.

Now, I don’t know exactly where the key constraints or pain points are in terms of reaching scale – there could be more than one which are significant. Finding investible companies is hard; finding philanthropists to donate must be hard, especially with the challenging economics and still relatively nascent state of the industry; and finding talent must also be hard, especially when it is necessary to focus on keeping costs low because of the challenging underlying economics of the business.

But the economics of the funds themselves are only a small piece of the overall issues in this space. One of my major observations from on-the-ground here in Kenya is that while these investments or companies are arguably doing a lot of good, they are very clearly not doing the best they possibly could. Governance is quite weak, and is clouded by the “double-bottom line”. When you’re doing good, it’s hard to set and enforce the bar for great – especially when what you’re doing has never been done before. There is frequently a lack of strategic focus – almost an inability to understand strategic fit. Anything that sounds good, sounds right, and needs to be done. As a result nothing is done effectively or efficiently. When you’re doing good, ideas rarely go through tight scrutiny. Even if the funds’ Investment Committees are doing a great job up in New York (which many in this space will tell you are in fact doing the opposite – holding up deals, largely for trivial, even egotistical reasons), the companies on the ground in Kenya and elsewhere frequently veer off course.

The fundamental issue is that when philanthropic capital is deployed anywhere, whether in a social enterprise or through traditional aid, there is insufficient ownership. The company, or more fundamentally the cause is somewhat orphaned. It’s exactly the same issue across this new Social Enterprise or Impact Investment approach, as was the case across the more traditional aid or direct philanthropy approach. In contrast to this, private capital, driven by the profit motive, creates a very strong and direct sense of ownership – profit is such a great motivator; and so easy to measure and reconcile.

This is a broad criticism, and one which is certainly not new – and even though it is a structural deficiency, I am by no means suggesting that we should do away with this industry all together. After all, profit-driven capital is not comfortable taking the risks inherent to this “patient capital” approach, so Impact Investing is extremely important and here to stay. But it’s a shame that the self-perception of those currently in this space (the marketing machines in some of these funds are remarkably strong) is quite different to the reality myself, and others (including one of the leaders of these funds I was having drinks with) see on the ground – bridging this gap is extremely important.

And to add to why this industry is so important – a bit of business rigor is better than none. I would not want to see any of these social enterprises run as pure NGOs (the acronym often means - "Nothing Going On"). Also, avoiding hand-outs preserves dignity and creates ownership – so there is value in making people at the base of the pyramid pay for goods and services, even though these goods and services are almost always “subsidized” within this space. I state that these goods are “subsidized” because most of these social enterprises are only in business, because of the lifeline which is low cost philanthropic capital provided by impact investing funds (in spite of the fact that both sets of players almost always claim to be “for-profit” or are at the very least shooting for sustainability). And precisely because this capital is subsidized or philanthropic, no one takes serious ownership of how efficiently it is used or how quickly it is deployed to achieve scale – “orphaned capital”, which is the core issue.

But at least the people who eventually buy the goods or services don’t know of or understand the subsidies or the way the philanthropy is being channeled, and retain their dignity and sense of ownership. (Overall comment: there have in fact been JPAL and other studies, carried out e.g. around mosquito nets in Kenya, which show that paying for something creates no difference in terms of eventual usage behavior or utility, but I do believe that dignity alone is extremely important to the human spirit, and that hand-outs can create “a sense of entitlement”, which can be very harmful).

Ultimately, I want to see Social Enterprise companies and funds managed to the same level of rigor and overall standards, as profit-driven companies. As always, people in leadership really matter – they can fill the gap in ownership, and move the industry from the mediocre standards where it currently seems to be stuck, towards a much higher bar. I am not saying that all leaders in this space should become extremely critical hard-asses, because no one likes to follow a critical hard ass. But we should be critical enough to know where we currently stand and use our charisma to inspire everyone to higher standards.

Overall, I think we need to see a shift in leadership from the old charismatic, even dreamy path breakers, to those who are a little more critical and pragmatic in their management approach. We need individuals with strong private sector experience, but those who are fundamentally geared towards driving social change. Those who are independent minded and bold enough to take on the risks inherent in pushing for higher standards. There’s much to be done, and choosing to follow the next generation of leaders wisely is the right place to start.