Life is unfair! Why not all businesses grow to scale

Life is unfair! We all know it, yet are still surprised when we find out that already well paid chief executives will also receive massive bonuses for example, especially whilst the rest of us are scraping around for loose change. Unequal outcomes exist throughout the social and economic worlds, grating with our expectation that things should be more fairly or at least normally distributed. In the trade, this is referred to as ‘non-Gaussian distribution’, and common examples include:

  • The richest 1% controlling 39% of the world’s wealth
  • The top 3 listed websites on a Google search getting 98% of the hits
  • Only 23 of a possible 7,000 English football teams having ever won more than 1 top-level trophy

It seems that in many areas of life, success breeds success, and it’s pretty hard for anyone else to get a look in. Hypothetically then we can assume the same will be true for SMEs. Of the 4.8m private sector businesses in the UK, 99.9% of all employment is provided by SMEs. But in terms of where capital is most concentrated, it is amongst the 4,800 businesses which employ more than 250 people each. These are the organisations most likely to provide the safe, low yield investments investors typically look for. This is a classic example of network effects at play – those with the most capital are able to attract the most capital!

I think this sort of logic causes issues when looking at social enterprises however. Clearly, only 765 out of a possible 70,000 (1%) social enterprises accessing social investment is a challenge. But network effects are at play here, and actually, is it realistic to expect all social enterprises to be in a position to accept the current suite of social investment products on offer? It seems more likely that, like SMEs, the majority of social enterprises will remain small or medium size, and only a small percentage will move towards scale.

What this means though is that to date, a lot of focus has been given to less than 1% of the sector (765 deals/70,000 social enterprises). This inadvertently devalues the output of the other 99%, and has understandably caused some friction. The issue is that the social enterprise sector hasn’t yet come up with a suitable alternative to traditional economic models, so subconsciously we still expect outcomes to be normally or equitably distributed and remain fixated by economic measures of ‘success’, such as rates of employment and turnover.

But it’s the social value created by this 99% which is of most interest to me and many others, as while it may lack the breadth of larger organisations, it almost certainly compensates for this in terms of depth and quality of interaction. But how can this work be financially supported?  There is of course already venture philanthropy and Angel investment. There are also a range of other approaches being developed and trialled in the sector – ‘repayable grants’, ‘convertible notes’ and even 13 year loans (with no repayments in the first three years) currently being discussed within Big Society Capital. Some of this arguably fits under the heading of ‘builder finance’, a concept recently put forward in this paper.

This is finance that is generally longer lasting than grant funding, and providers “accept only social returns for an initial period with a high risk of capital loss. Builder financiers may be prepared to fund enterprises without requiring any financial return at all, or they may wish to provide instruments that convert into providing a financial return once the business has achieved certain benchmark performance criteria for revenues, financial surplus etc. The latter is likely to require a commitment to supply funding for a lengthy period of time and enterprises should be prepared to negotiate terms that reflect a long-term relationship with the funder”.

This is clearly a good idea, and will definitely be welcomed by UK social enterprises. Whether it will build pipeline for the latter stage, high-risk growth capital currently prevalent in the sector though, remains to be seen. Following through the logic of non-Gaussian distribution, it’s actually quite likely that only a few ventures will pass through in to the red zone below, and most will stay in the purple zone.

Unfair? Most social enterprises already are, and will remain, in the purple zone.
Unfair? Most social enterprises already are, and will remain, in the purple zone.

This requires a shift in mindset within the sector. So long as these network effects remain so strong, most policy interventions are likely to have only a moderate effect at best in getting ventures to the ‘social expansion’ finance currently available. And actually, this would represent something of a success, given the trends witnessed amongst private sector businesses. Furthermore, developing the market at the ‘builder finance’ stage could have unintended benefits, namely a lot of well-developed, locally focused social ventures returning financial value over an intermediate period but generating sustained social value over the long term. So while life is unfair, this potentially could be a good thing!

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