Bridges & Batons: How Loans Can Keep Impact on Track in the Social Sector
While microfinance did not turn out to be the silver bullet to end poverty as some projected a decade ago, it has proven itself to be an invaluable tool for the working poor. The poor are more vulnerable to unexpected, external shocks — a death in the family, an extreme weather event, social unrest, or a public health crisis. Before microfinance, when those shocks occurred, often poor families would not have enough cash on hand to pay for the funeral or rebuild the house after a disaster. Instead, the working poor with no safety net would spend through their hard-earned savings or go into debt with a local money lender, dropping down to what is called the ultra poor (broadly understood as those living on less than $1.25/day). Microfinance changed this. Through microfinance banks like Grameen, families can access a microfinance loan, spending the needed cash in the moment and stay on track. In short, they have a safety net.
This is how I think of social enterprises — they are the working poor of the business world. They do not typically have access to the financial services a traditional company does. Banks don't understand their business model and they usually require collateral, such as liens on property, that social enterprises don't have. In emerging markets, banks will offer loans at high interest rates that the organization can't afford to pay. At Open Road Alliance, we've seen that one external shock — whether it be a local partner pulling out, a currency devaluation, or a delayed disbursement — puts these organizations at risk of failure. A management team can make all the right decisions, but the world is unpredictable. For a company without a safety net, an external shock can throw their business targets and social impact permanently off track.
These realities are true, if not more acute, for nonprofit organizations.
Building organizational resiliency as a social organization — whether a traditional nonprofit organization or social enterprise — is difficult. All the money earned or raised is reinvested into a social organization’s growth or programs. As funders, we can recommend the organization build three or six month operating reserves, but the fact of the matter is that the trade-offs to do so are often too great. If the choice is between making payroll or putting some funds aside for a rainy day, a leader will likely pick their employees every time.
In the absence of bank lines of credit or internal reserves, these social organizations are left with few options. It is not news that working capital is a huge need for the social sector, but few funders have stepped in to lend small amounts (under $500k) to small and medium-sized organizations (often smaller than $1M/year in revenue). Our hypothesis was that if these organizations had access to a working capital loan, they'd be able to withstand and overcome unexpected roadblocks.
In February 2017, Open Road incorporated its own loan fund, Open Road Ventures LLC, to solve this gap in the market. As of early December, we have approved 15 loans totaling $4.1 million – and we are planning to more than double that in 2018. While we're only 12 months into this loan fund experiment, demand has proven to be strong.
Open Road's average time from initial conversation to approval is between three and four weeks. In August, we made our fastest loan ever — just seven days. Our target borrower is a growing social enterprise (nonprofit or for-profit) that runs into an unexpected, external roadblock. When there is an emergency funding gap, we can respond quickly to solve the problem. From our perspective, we aren't even taking on that much risk. Many unexpected roadblocks don't actually take that long to solve. Open Road Venture's average loan term is around 12 months. Often, we are providing "bridges to somewhere;" for example, the organization's roadblock is a timing issue. Funding is forthcoming, but bills need to be paid today. When the promised funding comes in, Open Road is repaid. For Open Road, this is an example of "impact arbitrage." We're able to step in with a bridge loan, take little risk, and capture all of the impact upside, by ensuring the organization stays on its existing trajectory.
Although we do charge interest on our loans, Open Road is at its core a philanthropic initiative. We are seeking to maximize impact, not financial return. At Open Road, we believe the majority of the benefit should go to the investee. Our average interest rate is 3.5%, with rates maxing out at 7% for loans. We believe this better aligns us with the investee — our funding is here to get the organization out of a jam, to keep its growth and therefore impact on track. This also helps with our repayment prospects — as we only offer unsecured loans, we rely on the integrity and commitment of the founder or management team. The organization's impact is our number one priority.
For us, Open Road Ventures is an experiment. By providing one-time bridge loans to nonprofits and social enterprises, our goal is to demonstrate that these organizations are creditworthy — and that our loan fund can sustainably recycle capital to solve for future roadblocks.
We like to think of impact investing as a relay race: funders pass social enterprises, like batons, off to the next funder in the value chain as social enterprises grow in scale. However, right now, the impact investing “track” is littered with dropped batons. There are far too many instances in which an otherwise successful social enterprise doesn’t receive funding quickly enough to maintain growth and impact. Funders fumble, the baton is dropped. The goal for Open Road Ventures is to keep those batons in the air, long enough for another funder to come in for the hand-off. While Open Road’s bridge funding can buy a social enterprise important time to continue growing their impact and bringing in investors, we have to pass the baton to someone. There is a looming crisis of working capital that is suffocating growth and slowing the maturation of the social sector. We hope other funders will join us in providing working capital loans to these organizations. If banks think these companies are too risky, it is our role as philanthropic funders to step in and prove them wrong.
This article is the third in a four-part series sharing what Open Road Alliance has learned about risk management in philanthropy and how the organization has evolved over the past five years to better address the need for fast, flexible contingency funding in the sector. This series will include findings from Open Road’s research and practical guidance on best practices for managing risk in order to maximize impact in philanthropy.