Social Finance vs. Traditional Finance: What's the Difference and Why it Matters

Nov 25, 2013 | Updated Jan 25, 2014

Most growth businesses face challenges raising capital at some stage in their development. But for social enterprises, which use the power of business to directly improve society and our environment, the obstacles tend to be tougher and more persistent. That's unfortunate, because these enterprises are working on the world's most pressing social and environmental problems--and with sufficient investment, they have the potential to multiply or scale to provide real solutions.

Conventional startups attract investment by focusing on markets with huge, fast expansion potential and creating barriers to entry for competitors--they have hockey-stick growth prospects. The contrast with social enterprises can be stark. They often have high upfront costs and relatively low profit margins. They may have unproven hybrid business models. And, by definition, they aim to maximize social value rather than profit.

In short, social enterprises upend the expectations of traditional investors, lenders, and donors. By their nature they call for a fresh approach to funding: social finance. Social finance provides flexible, mission-aligned capital that meets social enterprises where they are. Its defining role is to support game-changing social innovations that don't meet the standard expectations of conventional finance.

RSF Social Finance's borrower roster provides numerous examples of why this approach is needed and how it works.

Restoring a Healthy Food System
Consider Common Market, which supplies more than 200 Philadelphia-area customers--institutional kitchens, retailers, restaurants and buying clubs--with produce, dairy and meat from about 100 sustainably run regional farms. Common Market is a nonprofit business: it invests any profits into expanding access to markets for farmers and to fresh food for urban communities. And rather than creating barriers to entry, co-founders Tatiana Garcia-Granados and Haile Johnston share their model widely with others seeking to create healthy regional food systems. At the same time, Common Market is a high-growth enterprise: year-over-year sales increased 45 percent in 2012. This combination of characteristics put it outside the bounds of both traditional business and traditional philanthropic funders.

With a focus on high impact potential over high profit potential, RSF saw Common Market as a good candidate for funding. In 2010 RSF provided a $150,000 credit line (since more than doubled) to help the enterprise address cash flow issues. When the enterprise began turning away orders due to lack of storage and packaging capacity, the founders knew they needed a new facility quickly, before the opportunities slipped away, but Common Market was still too small to qualify for the $1.3 million mortgage loan required. RSF worked closely with the founders to secure the loan with an innovative package of grants, guarantees, and debt financing.

Restoring the Rainforest
Another RSF borrower, Guayakí, has pioneered what it calls the market-driven restoration model, developed in pursuit of a mission to restore 200,000 acres of endangered South American rainforest and create more than 1,000 living-wage jobs by 2020 in communities that would otherwise face intense economic pressure to destroy the rainforest to raise cattle or grow soy. The California-based beverage company sells yerba mate, a stimulating rainforest plant, as a loose-leaf tea and in canned and bottled drinks. Guayakí partners with farming communities in the Upper Paraná Atlantic rainforest to produce shade-grown organic yerba mate and to reforest their land with native hardwoods, and it pays a premium to support fair wages, healthy working conditions, and community development projects. The result: Rainforest preservation is no longer tied exclusively to the generosity of donors or government policies.

As with all true social enterprises, Guayakí's growth directly increases its impact--so Guayakí wants to grow. But mission-based decisions about what the company pays for yerba mate, who it buys from, and how far in advance it commits to contracts can result in logistical puzzles, cash flow strains, and gross margin challenges. In 2009 the company faced a dilemma: it needed capital to grow, but the founders wanted to maintain control of their business--and their mission--and banks weren't lending money to pre-profit companies at the depth of the recession. The situation was a perfect match for a then-now RSF program to precisely fill this sort of funding gap: growth capital for social impact businesses that don't want to take on more equity partners and aren't seeking a quick exit. With a $500,000 subordinated loan, Guayakí was able to roll out its canned beverage line, develop its small-store delivery distribution model, and build inventory. Today, the company qualifies for a $1.9 million line of credit from RSF--relieving some of the financial strain faced by a company trying to compete against beverage behemoths and solve social and environmental problems.

Pioneering Fair Trade Fashion
Indigenous is another illustrative example. The Northern California-based company produces a full line of premium fashion knits sold online and at 500 independent stores, as well as clothing for major brands and private labels hanging on racks at the likes of Bloomingdales, Neiman Marcus, and Nordstrom. They do it using a supply chain of more than 1,500 artisans in small knitting groups around the world, paying fair living wages and using organically grown fibers, low-impact dyes, and handmade fabrics. Developing that supply chain took many years, and financing was a huge obstacle.

Seeing the immense need for positive change in the garment sector, RSF provided working capital, helped Indigenous formalize its financial strategies, and helped the business attract other socially minded investors. In 2010, RSF helped finance Indigenous' effort to create standards and procedures for the Fair Trade apparel pilot program and to develop the Fair Trace Tool™, which allows shoppers to scan a hang tag QR code to find out where a garment originated, who made it, how the fibers were raised, and what the social impact was. Indigenous has continued to grow and is no longer a borrower--but has become an investor in RSF.

All the companies above--and many others like them--are tackling issues of daunting scale. Until there's a Common Market equivalent in every major city, we will not have achieved a healthy food system. Guayakí's sales have led to the restoration of more than 31,000 acres of rainforest, yet 35 million more are lost every year to timber harvesting, cattle ranching, and monocrop farming. Indigenous has pumped over $20 million into the artisan and organic supply chain and is promoting wide use of Fair Trace, but as the recent tragedy in Bangladesh illustrates, ethical fashion is still a long way off. To reach its full potential, the growing and maturing social enterprise sector requires an equally robust social finance sector.