By Jennifer Walske & Laura D. Tyson

In our research, we took a deep dive into eight successful social enterprises in order to identify the critical elements of their success.

In our previous post, we discussed the surprising importance of media as an X-factor in accelerating a social start-up’s footprint and growth.

In this post, we turn to the challenge of securing early funding, which is crucial to growing a social enterprise beyond its infancy.

We discovered several important strategies to find funders. These include participating in and winning social venture competitions, which build credibility and provide a perfect backdrop for meeting angel investors.

We also found that it’s essential for social enterprises broaden their funder base within the first few years. Though initial financing often comes from philanthropic sources or social venture capital firms, we found that successful social enterprises also draw funding from traditional venture capitalists and other for-profit investors. Indeed, both traditional VCs and social-purpose VCs tend to have a better understanding of the need for product innovation and the kind of investment necessary to bring new products and ideas into the mainstream marketplace.

Rugged Funding Landscape

The truth is that financing a social venture start-up is usually more complex and difficult than financing a standard high-tech start-up. This is because social venture funds, though growing in number and prominence, are usually smaller and less established than traditional venture capital firms. Unlike traditional venture firms, which measure their success based on their ability to “exit” investments through public stock offerings or buy-outs, social venture funds seek both a social and a financial return on investment. Unfortunately, the definition and measurement of that social return is often unclear for funders and the funded alike.

Having said that, we identified several important lessons in raising capital for a social venture start-up. Women have been both founders and early investors in many social enterprises, and we focused on two women-led start-ups: Embrace and Revolution Foods.

The first lesson is that corporate form matters. It is easier to raise large amounts of capital if a social enterprise is a for-profit rather than nonprofit enterprise. That is because equity investments are more common investment vehicles for high-risk start-ups in the product-development stage. In contrast, non-profit donors are more used to funding specialty programs, rather than new product development.

Second, social venture start-ups can benefit immensely from entering targeted business-plan competitions. The competitions themselves provide only small amounts of capital in the form of prize money, but they offer enormous access and visibility to potential angel investors. Winning such competitions can be a valuable pre-qualifier for larger venture firms, especially when the social start-up is very young.

Embrace and the Corporate Form

Embrace was founded by Stanford students participating in Stanford University’s Institute of Design’s course, Design for Extreme Affordability. Founder Jane Chen and her team had been tasked with creating an alternative to the traditional infant incubators, which are often unsuitable in impoverished nations because of their high price, dependence on electrical power, and periodic need for expensive and hard-to-get replacement parts.

Chen and her co-founders designed a special wrap that keeps premature infants warm without the use of electricity. In addition to its simplicity, the product costs a minuscule fraction of the $20,000 price-tag for an incubator.

Embrace got off to a fast start by winning two business-plan competitions early on, which led to seed investments from judges and from Stanford alumni: “We won Echoing Green and Stanford BASES the same day,” Chen recently recounted. “This ultimately allowed us to get more feet on the ground in India, which was our first target market…. Alumni networks are also important, which led Mulago Foundation to invest in Embrace.”

However, the founders of Embrace soon had to re-think their plans for raising follow-on capital.   They had launched Embrace as a nonprofit enterprise, hoping to form distribution partnerships with non-governmental organizations such as the Red Cross, UNICEF, and the World Health Organization.

To Chen’s chagrin, however, the NGO’s deemed Embrace’s product “unproven” and did not place orders. This forced her to turn to philanthropic donors for capital, which easily consumed more than half of her time. The timing of these funds was also unpredictable, with donors deciding when and if they would continue donating. On top of that, Chen told us, donors rarely understood the need to fund product innovation and did not recognize that product development could take years, instead of months. Embrace’s pediatric products needed to go through expensive clinical trials.

The long fund-raising cycle, combined with the lack of advance orders from NGOs, ultimately forced the co-founders of Embrace to pivot in their approach. Chen created a new for-profit entity, Embrace Innovations, which was able to attract a sizable equity investment from Khosla Impact, a social venture fund. That in turn made it possible to ramp up product development and manufacturing.

“In the beginning we thought we could do almost anything with a million dollar and two people,” Chen recalled. “But then you realize there’s manufacturing, distribution, clinical trials and all the other functions of a business.”

Calling all Venture Capitalists

Revolution Foods, which produces high quality school lunches and consumer products, got its initial boost by placing first in the Berkeley-Haas Global Social Venture Competition. The prize money provided co-founders Kristin Groos Richmond and Kirsten Saenz Tobey with a small amount of prize money, but more importantly it led to a $50,000 investment from angel investor, Dick Beers, and then to a $500,000 investment from DBL Investors.

Those investments allowed Kirsten and Kristin to get a truck, lease kitchen space, and hire four additional employees, including an executive chef, two prep cooks and a driver. That in turn enabled them to run a pilot program, which provided the proof of concept for their business model and paved the way for additional investors. Nancy Pfund, founder of DBL Investors, told a recent Berkeley-Haas colloquium on social finance that she quickly saw the potential for Revolution Foods, leading her to supply meaningful early stage funding.

“I met Kristin and Kirsten at Haas, and immediately saw the value of their idea,” Pfund said. “Providing large amounts of early capital is extremely important for founders who are proving the field.”

Another key lesson from Revolution Foods is the value of seeking funding from traditional for-profit venture capital firms. Revolution Foods began as a for-profit enterprise, though one with social goals, but it raised money from both kinds of investors.   The social venture capital firms included DBL Investors, Catamount Ventures, New Schools Venture Fund, Physic Ventures, and the Westly Group. But they also garnered significant financing from traditional VC firms, led by Oak Investment Partners. Revolution Growth, the venture capital fund created by AOL founder Steve Case, recently invested $30 million.

One hurdle for social venture capital investors is the lack of standardized metrics for assessing social impact. According to Kirsten, Revolution Foods developed its own metrics rather than relying on frameworks developed by its investors. And, now that Revolution Foods is B Lab certified, which provides some standard guidelines for social impact, the process of social impact measurement has become even easier.

In closing – what are the steps social entrepreneurs should take to find funders? Winning competitions is clearly important, because it allows an unknown and unproven start-up to catch the attention of serious angel investors and experts.   If winning a competition leads to media coverage, which it often does, so much the better: the company can establish a “larger than life” presence that is crucial to establishing credibility with investors and business partners.

Our research also suggests that philanthropic donors and nongovernmental organizations may not be the best sources of capital. The experience of Embrace indicates that nonprofit donors often have a limited understanding of the need for product experimentation and innovation. Venture capitalists, both the social and traditional kinds, are far more likely to understand those imperatives, as well as the size and kind of investment that will be necessary to accomplish them.