Our partners:

Comparison of Financing Instruments (click to enlarge)

Financing Instruments for social businesses. An overview (Schwab Foundation)

When determining the right financing instrument, social entrepreneurs should ask themselves the following questions: 

  • Can we set aside capital that would allow us to repay in a few years any financing received? 
  • In thinking about ways our organization might grow, can we take on capital that requires annual interest or dividend payments (e.g. 5% interest) throughout the course of the financing? 

Those financing instruments are described in more detail below. 

Grants are a traditional form of financing in the social sector that are provided by foundations or individuals and continue to be an important funding source for social enterprises. Despite their importance, there are some shortcomings related to grants. Grants are regularly provided only for certain projects and usually exclude overhead costs and expenditures for the development of the social enterprise. Furthermore, grants are usually short-term, not predictable and impose high fundraising costs on the social enterprises. 

Equity capital is the financing instrument with the highest risk for the investor. The social investor gives the social enterprise a certain sum in exchange for a share of the company (e.g. 10% of total shareholdings). The social investor receives no regular annual payments but a share of the profits generated by the social enterprise. Besides a share of future profits, the social investor has certain control and voting rights. Control and voting rights depend upon the legal form of the enterprise and are usually structured in the contract between investor and investee. 

Debt capital can be used for long-term investments or project financing that promise stable and predictable cash flows over the next years. The stable and predictable cash flows are necessary as the debt capital providers receive an annual interest payment. Debt capital is provided on a temporary basis and requires repayment after a few years. Normally, the loans are provided for five to seven years.
Mezzanine capital combines elements of debt and equity capital and represents a convenient financing alternative if pure equity or debt capital is not applicable. The interest payment can be linked to the profits of the company, whereas the total amount is repaid after a certain time period or converted into equity capital. The structuring flexibility makes mezzanine capital an attractive option for social entrepreneurs as well as social investors. 

Hybrid capital contains elements of grants, equity and debt capital. The grant character can be explained through the fact that there are no interest costs and, in certain pre-agreed scenarios, the financing instrument is converted into a grant. Financing instruments with hybrid capital character include recoverable grants, forgivable loans, convertible grants and revenue share agreements described below. 

  • A recoverable grant is a loan that must be paid back only if the project reaches certain previously defined milestones. If the milestones are not reached, the recoverable grant is converted into a grant. This mechanism can be used if success of the project enables the social enterprise to repay the loan to the social investor. 
  • A forgivable loan is a loan which is converted into a grant in the case of success. If the social enterprise reaches the goals agreed on beforehand by the investor and investee, the loan does not have to be repaid. 
  • A convertible grant is another financing instrument with hybrid capital character. The social investor provides the enterprise with a grant that is converted into equity in the case of success. 
  • Revenue share agreements are financing instruments with which the investor finances a project and receives a share of future revenues. This risk sharing model can be used for the repayment of the financing and gives the social enterprise financial flexibility. 

Source: "Social Investment Manual: An Introduction for Social Entrepreneurs", developed by the Social Investment Task Force consisting of Technical University Munich and Schwab Foundation, September 2011

Dowload free the full document