SOCIAL ENTERPRISES: FINANCING

SOCIAL ENTERPRISES FINANCING

Social Businesses Go Searching for Grant Funding 

Businesses that marry some commercial returns and social good are increasingly turning to grants for funding. Critics say the ‘free money’ will make them lazy. Backers say it facilitates greater expression provided terms are attached to it.

    In its two years, Hippocampus Learning Center has started 80 kindergarten centres in rural areas, with daycare facilities for 1,250 children. The 9.3 crore in capital the company raised from impact and angel investors funded much of its expansion, in Karnataka. It needs more, but Umesh Malhotra, CEO and founder, is curbed by the limitations a social business faces as it walks the delicate balance of marrying social good with some commercial returns. Investors seek returns, making raising equity difficult as compared to commercial start-ups. So, Malhotra is trying something few social businesses in India have managed this far: grant funding, which doesn’t seek a payback. Malhotra is tapping foreign non-profits and philanthropists to raise money that does not carry the expectation of equity or debt. He has raised 35 lakh in grant funding, and is talking to donors for 1 crore more over the next two months. So far, Malhotra has used the grant money to open more centres and develop curriculum. Going forward, he adds: “We are exploring ways to use grant money for R&D and pilots because these are one-time investments for innovation and should be supported by grants.” Social businesses using grant money evokes both support and concern. “For start-ups serving the poor, grant money is absolutely necessary to innovate, incubate and create new ideas for overall sustainability of this sector,” says Sadeesh Raghavan an individual philanthropist who funds social enterprises. But Venkat Krishnan, who has worked with and mentored 15-20 social enterprises, warns grants can be abused. “Entrepreneurs treat such grants differently,” says the founder of GiveIndia. Drawing from both kinds of experiences, donors and social businesses are increasingly gravitating to a middle path: the grant money is free in that it is not tied to a financial payback, but it is not free in that donors link it to deliverables.

Regulatory Barriers

In India, however, the channelling of grant money to social enterprises is being reined in by tax rules: Indian non-profits organisations cannot give money to a for-profit business and claim tax deductions. “The government is saying that tax deduction contribution should be used for charitable purposes. How do you define charity as a for-profit?” asks Ankur Shah, interim India director, Acumen Fund, a nonprofit global venture fund. According to Noshir Dadrawala, a legal expert specialising in charities and good governance practices for non-profits, social enterprises do not have a legal definition in India, and this needs to change. “It will be a herculean tax to prove to the tax authorities in India that a social enterprise registered as a private company exists for charitable purposes,” says Dadrawala, CEO of the Center for Advancement of Philanthropy. A small change happened this May, when India’s capital market regulator allowed social venture funds to act as intermediaries to direct donor funding —of all varieties—to social enterprises. A new category of funds still does not resolve the demand that grants to social enterprises earn tax breaks. But it does set up a platform where donors who don’t have investment expertise and who are not fixated on a tax break can give to a social business. “The regulation came in the wake of a lot of interest from a number of organisations and individuals who want to encourage the growth of social enterprises,” says Siddharth Shah, partner and head of funds practice, Nishith Desai Associates. Currently, most social venture funds operating in India are offshore. “Very few donors in India are giving money to social businesses,” says Vineet Rai, founder of Aavishkaar, a venture fund that invests in social businesses.

The Case For Grants

Harvey Koh, associate partner of Monitor Inclusive Markets, a consultancy, says social enterprises are trying new business models and that, in most cases, a market for the product or service does not even exist. “Because most social enterprises did not generate high returns, on investment, it is hard to attract investors into earlystage companies with innovative models where the risk is high,” he says. “This is where grant money needs to plug the gap.” Take Global Easy Water Products (GEWP), a dripirrigation manufacturer spun off from the non-profit IDEI (International Development Enterprises India) in 2008. IDEI had developed a low-cost dripirrigation system for farmers with small fields. However, IDEI and, subsequently, GEWP faced a problem: such farmers had no previous experience with drip irrigation and, therefore, no appreciation of its benefits. In 2007, IDEI received a $16 million grant from the Bill and Melinda Gates Foundation to create market awareness for such systems. “This grant money was essential to create awareness among farmers who switched to drip irrigation to save water and associated costs,” says Harish Chandra, CEO of GEWP. A recent research report by Monitor and Acumen Fund, titled ‘From Blueprint to Scale’, refers to the early stage of developing a new business when access to capital is missing as the ‘pioneer gap’. Here, grant money represents the ultimate ‘risk capital’ for such businesses because it does not carry the rider of financial return, and can tolerate uncertainty around commercial viability.

Conditions Apply

Krishnan of GiveIndia, however, feels a for-profit company attains an unfair advantage if it uses grant funding to promote its product or service. He cites the example of IDEI and GEWP. “The parent (non-profit) is promoting the cause and the entity (for-profit) is serving that cause. This is a clear conflict of interest.” Krishnan adds it also distorts economics, as happened with rural Internet kiosks businesses that were spun off from NGOs around 2003. Low prices and high salaries, facilitated by grants, killed the market. “They received grant money: 15- 20 crore was pumped into each enterprise,” he says “Employees received high salaries of 2-3 lakh (a year). Six years later, none has survived.” Krishnan’s critique evokes a strong response from Gyanesh Pandey, the co-founder and CEO of Bihar-based Husk Power Systems. His company generates power from rice husk, and supplies it to villages at a subsidised rate— 100 per month to power two light bulbs and a mobile charger. “What does society give to an enterprise like us?” Pandey asks rhetorically. “We have to practically innovate, invent and create from scratch almost everything we need — machines, gadgets, processes, people…there is no way equity or debt can do all this.” Grant money played a crucial role in Husk Power’s growth. The Shell Foundation, beginning 2008, gave $2.3 million in grants. This helped Husk raise $1.65 million in early-stage funding in 2009 from six investors: Acumen, Bamboo Finance, Cisco, Draper Fisher Jurvetson, IFC and LGT. Pandey adds that grants are not ‘free’ and are tied to deliverables. “Our grants were not conventional and had stringent targets that were the business building blocks,” says Anuradha Bhavnani, regional director, Shell Foundation. From the outset, Husk charged a price its low-income, low-usage consumers could afford, and which also ensured the company’s long-term survival. The Shell Foundation also helped Husk do further R&D to reduce the plant cost by 25%, and implement health, safety security and environment audits. Monitor’s Koh says a combination of restriction, conditionality and reporting requirements can make grants more prescriptive at an operational level than equity or debt. It seems the more sustainable approach to social progress is partnerships between NGOs, government, corporations and philanthropic organisations. Boundaries are blurring.

Ahona Ghosh ET121016