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Seebohm Hill - Connecting social entrepreneurs and social investors to deliver innovative ways of meeting social need

Builder Capital

Introducing builder capital:

Such capital is needed to:

  • Pay for the establishment of the organisation
    • Key staff
    • Premises
    • Mission-critical equipment, software or processes
  • Fund R&D to develop services / products
  • Absorb losses while a viable business model is established

To continue the construction industry terminology, builder capital can be considered to be the financial scaffolding which supports the formation of a financially sustainable organisation during its earliest phases of development.

It needs to be “ultra-patient” capital. Conducting R&D and establishing a viable organisation takes time in any field. It can be especially difficult for those trying to innovate in the solution of social problems. Commercial companies would normally fund R&D from profits, retained earnings or reserves. Social enterprises are much more limited in the funding options available to them.

For many social organisations, the key transition needed is from grant funding to revenue and contract-based models. The difficulty is that much of this is new and, in many cases, the markets do not exist at the moment. This would be difficult enough if it were organisations looking to enter already well-established markets, but it is especially hard when services have previously been grant funded or contracted by the public sector and where there is such rapid change occurring in commissioning arrangements and suppliers of service.

In many such cases there will be market dysfunction for a time while suppliers, customers and funders sort out what is achievable and how. In some cases there may be absolute market failure, meaning that grant funding will be the only way for services to meet social need to be funded. It may not necessarily be obvious at the start which markets are capable of offering viable business opportunities and which are not. The only way to find out is for enterprises to offer product or services to customers, discard what doesn’t work as quickly as possible, and develop what does work until a successful revenue model has been achieved.

This is market-making from first principles. It takes time and it requires the answer to some fundamental questions, such as:

  • What does the demand-side look like?
    • Who is the customer – who will pay for the services provided?
    • What services are customers prepared to pay for?
    • At what price?
  • What does the supply-side look like?
    • What services are required in order to meet the need?
    • How much will it cost to provide the services required?
    • What is the appropriate price to charge for those services? 
  • Where is the equilibrium?
    • Is there an equilibrium – does a viable market exist in meeting this need? 

Financial return expectations in these markets need to be low. Cost structures are likely to be high and service/product pricing challenging, not least because of the moral/political problems associated with being perceived to be earning high financial returns or making money out of other people’s misfortune or difficult circumstances. That means profit margins will be low. Models that closely meet the social needs of individual beneficiaries may face challenges in scaling up. These are P2P models (people to people), not B2B (business to business). But the overall addressable market is often very large so those enterprises that are able to find viable business models may eventually be able to achieve meaningful scale if they can find ways of moving beyond local geographical markets or localised client groups, perhaps by franchising or other means.

Builder capital key features:

  • Investors start by asking “is there an innovative market-based solution to this social problem?”
  • And then “can the social enterprise providing the solution achieve sustainability if supported in the right way and with appropriate funding?”
  • Builder capital is ultra-patient with no predetermined repayment schedules
  • Capital is at risk
  • Builder capital will deliver social returns only while the social enterprise achieves pre-agreed measures of sustainability
  • Builder capital will deliver modest financial returns which are directly related to the success of the enterprise only when sustainability is achieved.
  • Definitions of how financial returns are to be delivered (share of revenues, financial surplus etc.) and applicable thresholds will be agreed in advance and built in to contracts that will be binding on all parties as soon as builder capital is provided to the enterprise
  • No ownership stake in the enterprise is required although an equity stake could be negotiated if that is the best way of meeting the needs of both the social enterprise and investor, provided that governance structure allows equity