Financing Fantasy #2: Venture Capital

By Rolfe Larson on August 10, 2011

At first blush, venture capital sounds appealing.  In theory, they can provide us with that hunk of cash we need to launch our great idea, and then when we succeed they can make a decent return while we make a big difference in the world.  We just need a business plan to show them how profitable we’ll be and then they’ll invest in us, right?

What is Venture Capital?

Venture capital (VC) comes from a private fund that invests equity in high-potential, high-risk startup ventures.  Unlike angel investors who are well-to-do individuals investing their own dollars, VCs are firms that pool capital from numerous individual and institutional investors.  VCs usually focus on companies that offer a unique technology or compelling business plan for quick growth.

They look for deals that will provide them with two things.  First, a high return on their investment to compensate for the high risk that they’re taking.  They seek to get that return from selling the company in a few years (or an initial public offering), and secondly from gaining significant ownership and control over decision-making at the company.  One rough rule of thumb is a goal to double their investment in value in three years.

This is pretty stiff coffee for most ventures.  And the odds are pretty low too.  Of the roughly two million businesses started each year, only about 700 get venture capital funding.

Venture Capital And Social Enterprises

For 99% of social enterprises, VC is not relevant.  First, since no one can legally “own” a nonprofit organization, any social enterprise that is part of a nonprofit organization cannot, under current law, meet VC’s ownership requirements.

Secondly, since social enterprises by definition seek to “directly address social needs through their products or services or through the numbers of disadvantaged people they employ,” it is hard to imagine even a forprofit company with that unwavering focus achieving the growth rate that VCs expect.

Not impossible, but highly unlikely.  Indeed, a recent study of 740 operating social enterprises found that none of them reported venture capital as a source of startup capital.

In a future blog, we’ll review what kinds of investments do make sense for social enterprises, depending on where they are in the life cycle of their venture.

Good luck!