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May 22, 2014

Scaling Social Impact – Friend or Foe?

The Social Impact Exchange has decided that social innovations that are scalable deserve a big boost.  To accomplish this, it has launched its Scaling Marketplace.  It functions much like a member investment fund in which members of its working groups nominate nonprofit organizations for review.  The exchange staff and working group members perform an extensive due diligence process to ensure the nonprofit has the capacity, skill, staffing, and planning necessary to scale successfully.  If the review is favorable, “Working Group members provide a portion of the growth funding needed for scaling each investment (“lead funding”) and then distribute the investment opportunities to broader networks of potential funders to complete the growth capital needed for scale up.”  In effect, this is akin to syndicating the investment or having an “opt-in” investment fund.

 

The due diligence process  for evaluating scaling potential is very interesting.  “Conducting due diligence on scaling carries a particular set of expectations…The funders in our Working Groups care about the viability of a scaling strategy, particularly in terms of financial planning and staff capacity, and want to ensure that the nonprofit understands what it takes to scale and what its vision of for sustainability is, both at the national and local levels….Due diligence teams will assess an organization’s scaling mechanism and aspects of the model that will inevitably change with its scaling plan, key success factors, market demand including the potential for new market entry, and capacity needs for scaling (e.g., staffing model and investment in systems and revenue generation.)”

I certainly understand the Exchange’s special effort on scaling.  For social innovations that can be successfully replicated, the availability of capital can too often become a barrier.  More commonly, the lack of access to social enterprise capital can force even the best ideas to be underscaled and therefore to fall short of their potential.

But the question we must ask ourselves is whether scalability should rise to such importance in determining the merit of an investment.  This is certainly of prime important in commercial angel investing, in which the potential for high double-digit IRR’s virtually requires the ability to scale.  Nowadays that creates a bias in favor of physical products and software “apps” and a bias against service businesses.

But in the world of nonprofits and social good,  services are the predominant form of business activity.  And service is a very LOCAL  line of business.  Are social enterprises that scale more investment-worthy?  Are they “better”?

What I look for in social enterprise are two things:  a strong LOCAL impact on the community and a profitability that can strengthen the parent nonprofit’s financial sustainability to support its LOCAL mission activities.  Will scaling a social enterprise increase the LOCAL impact?  I don’t know, but I would be skeptical because of what I see in the for-profit sector.

First, job creation is an important social benefit of a social enterprise.  In the for-profit arena, small businesses remain the primary source of job creation, not the large, national firms that have the most scaling potential.

Second, the experience of local firms that scale and go national is that their focus on their home town becomes diluted, sometimes to the point that the headquarters moves to another city.  In that case, scaling ultimately works to the detriment of the home town.

So we must ask ourselves what is the purpose of social enterprise?  I don’t think the purpose is to get big and generate huge revenues for the parent nonprofit, though that certainly is a significant benefit.  Rather, I think the purpose is to enhance the local community by creating jobs, supporting the underlying mission activities of the parent nonprofit, and creating strong social benefits for the community.

While I certainly applaud the Scaling Marketplace for bringing capital to those few social enterprises that are scalable, I hope that the 5,000 members of the Social Impact Exchange don’t look down their noses at the non-scalable social enterprises which I believe hold as much or more potential to help our local communities.

The large social impact investment funds already send 70% of our nation’s social capital outside the United States according to the Global Impact Investing Network (GIIN).  I believe we need to refocus on our communities.  While poverty in our local neighborhoods may not tug at the collective heart like a story from the third world, that poverty (of mind, body, and spirit) is no less deserving of our philanthropic capital.

That is why the Community Investment Network of Central Ohio (CINCO) insists that its investments stay in the community.