How to Build Financially Sustainable Social Enterprises

A Note on Finan­cial Sus­tain­abil­ity for Social Enterprises

Pro­fes­sor Den­nis Shaugh­nessy, Feb­ru­ary 2012

Tra­di­tional busi­nesses find a path to finan­cial sus­tain­abil­ity by grow­ing their rev­enue, improv­ing their gross and oper­at­ing mar­gins, increas­ing their free cash flow, effi­ciently man­ag­ing both cap­i­tal expen­di­tures and work­ing cap­i­tal, and build­ing their asset base.  Achiev­ing these finan­cial per­for­mance indi­ca­tors typ­i­cally result in easy access to financ­ing and higher stock prices.

 High impact social busi­nesses are also built and man­aged to achieve these finan­cial goals, except that social busi­nesses value social impact over profit, and unlike a tra­di­tional busi­ness (espe­cially a pub­licly traded one), they use profit as a tool for mak­ing a mean­ing­ful social impact.  Well run social busi­nesses often cre­ate foun­da­tions to which they can con­tribute their excess prof­its, to fur­ther their mis­sion.  This is a “hybrid” struc­ture that is per­haps the most effec­tive approach to achiev­ing broad, sus­tain­able impact.

For non-profit social enter­prises, income gen­er­at­ing activ­i­ties (IGAs) enhance finan­cial sus­tain­abil­ity by reduc­ing depen­dence on the gen­eros­ity of donors or the bud­gets of grant giv­ing foun­da­tions and gov­ern­ment agen­cies.  A char­ity with­out IGAs is per­haps the most vul­ner­a­ble enter­prise model from a financ­ing stand­point, but to be sus­tain­able must estab­lish to donors that they are effi­ciently and effec­tively achiev­ing the impact goals that they share with their donors.

What are the keys to finan­cial sus­tain­abil­ity for lead­er­ship of an impact dri­ven enter­prise?  Here are nine sug­gested steps for insur­ing finan­cial sus­tain­abil­ity for social enterprises.

1.  Aggres­sively grow your revenues

           Whether your rev­enues are from prod­uct sales (price times units sold) or dona­tions and grants, double-digit (10% or more) rev­enue growth is crit­i­cally impor­tant to build­ing and main­tain­ing a dynamic, high impact organization

2.  Incre­men­tally improve your gross and oper­at­ing profit margins

            Effi­cient and pro­duc­tive enter­prises care­fully man­age the costs of mak­ing their prod­uct (or deliv­er­ing pro­gram ser­vices) and the expenses of oper­at­ing or admin­is­ter­ing the orga­ni­za­tion.  Your gross profit (rev­enue minus costs of pro­duc­tion or ser­vice) and oper­at­ing profit (gross profit minus the firm’s expenses) are the fuel for achiev­ing impact. 

3.  Care­fully man­age your work­ing capital

            Being a good bal­ance sheet man­ager is impor­tant to the effi­cient use of cap­i­tal from any   source, from cash and cash equiv­a­lents to payables to receiv­ables and inven­tory.  A well man­aged work­ing cap­i­tal account (cur­rent assets minus cur­rent lia­bil­i­ties) can be a buffer against short-term rev­enue downturns.

4.  Effi­ciently invest cap­i­tal in needed growth projects

            Cap­i­tal expen­di­tures, or “cap-ex”, is an impor­tant use of cash and should always be done using the man­age­r­ial tools of return analy­sis (ROI,IRR, NPV, breakeven analy­sis).  Invest­ing in the busi­ness or the mis­sion should be done with the inten­tion of cre­at­ing value for all stakeholders.

5.   Con­tin­u­ously increase free cash flow

            Prof­its are impor­tant, but cash is the lifeblood of all enter­prises.  Free cash flow (oper­at­ing income (or EBIT) plus depre­ci­a­tion minus cap­i­tal expen­di­tures (cap-ex) should be nur­tured and steadily increased to insure that the enter­prise has the resources it needs to achieve its strate­gic impact goals.

6.  Steadily build your asset base

            It’s impor­tant to build a “cush­ion” of cash and other key assets in order to man­age through and sur­vive any down cycles or unex­pected dis­rup­tive events.  For non-profits, this “sur­plus” is key to mov­ing for­ward with impact-driven activ­i­ties even when cur­rent dona­tions are down.

7.   Use low-cost debt in man­age­able amounts as a financ­ing tool

            If you need debt to finance oper­a­tions, be sure to actively man­age insti­tu­tional debt– to avoid it man­ag­ing you.  Care in obtain­ing the best avail­able terms for your par­tic­u­lar cir­cum­stances (inter­est, term, repay­ment sched­ule) is essen­tial.  Low cost debt can be an effec­tive tool for fund­ing a vari­ety of mission-related activ­i­ties that gen­er­ate income.

8.  Engage with the new “impact invest­ing community”

            There is a grow­ing com­mu­nity of investors, mainly wealthy indi­vid­u­als often orga­nized    into social invest­ment funds, who are inter­ested in invest­ing in the mis­sion of social    busi­nesses and enter­prises rather than donat­ing.  They can invest with equity or debt, with low­ered expec­ta­tions for returns.  This “patient cap­i­tal” can be a valu­able source of     growth financ­ing for impact enterprises.

9.  Con­fi­dently make your case to all of your stakeholders

            If you are suc­cess­ful in the pre­ced­ing eight steps, then the final step is to clearly and force­fully make the case to all of your stake­hold­ers why your enter­prise deserves their con­tin­ued finan­cial sup­port.  Stake­hold­ers in a high impact busi­ness include investors and lenders, donors and grant providers, clients (includ­ing poor fam­i­lies) and cus­tomers,        impacted com­mu­ni­ties, and employ­ees.  Finan­cial sus­tain­abil­ity is what makes your mis­sion and social impact both mean­ing­ful and last­ing for all of your stakeholders.