Funding Social Enterprises through Financial Engineering

One of the most important features to creating a successful social enterprise is obtaining long-term financial sustainability.  However, it also turns out that this is one of the most difficult outcomes to achieve for many, if not most, social enterprises.  The often sought out approach to this problem is to simply raise enough capital through profits or other means such as charity, donations, and grants.  These are all great means to raise capital but they can often miss the mark.  Profitability is much easier said than done and relying on charity and donations is risky because there is no guarantee you’ll secure those donations the following year. 

This is where financial innovation/engineering comes into play.  The article “A New Approach to Funding Social Enterprises” argued that it’s possible to apply financial engineering to social enterprises to make them more sustainable.  Now of course, not every new financial tool mentioned in the article is going to fit just any social enterprise.  Each social enterprise will need to brainstorm how they want to raise money after assessing how much capital they’ll need and the risk that investors will take on by investing in them.  One of the most innovative, and also controversial of those tools is known as pooling funds.

Pooling funds can be very effective if done right.  One example of pooling is securitization.  Coming from a finance background, I’ve had some experience with securitization and I know how controversial of a topic it can be.  Take credit card debt for example.  Credit card debt from thousands of individuals can be pooled together into a security or a collateralized debt obligation (CDO).  This security is handled by a trust (your bank still handles your credit card account) and is known as an asset-backed security, or ABS.  The trust will then find investors for the ABS such as pension funds, mutual funds, or individual investors.  Once you as a cardholder make payments on your account every month, most of that money will go to the trust, who then pays the investors in the ABS.  The reason this process can be so effective is that it provides the banks/credit card issuers with a source of consistent funding (by selling the debt and they also get part of your payments) and it transfers the risk to the trust and the investors.  Now, this can be an extremely complex process but imagine the good it can do for social enterprises.  The government or some foundation with a lot of capital could give out low-interest loans to these social enterprises.  The debt from these loans, much like in the credit card example above, could be securitized into a CDO and handled by a trust.  This trust could then sell this debt as a social asset-backed security (I just made this up off the top of my head) and sold to investors.  Granted, this is something I just made up off the top of my head and it has drawbacks but the point is that there are numerous ways to use finance to help sustain social enterprises and it makes the private and public work together.  The question is, how do we assess the risk of these social enterprises and how do we get private investors more involved?