INTRODUCTION
The term “social business”, which was first coined by Nobel Laureate Professor Dr. Mohammad Yunus, is now a reality in the economic world. The enthusiasm shown on this idea by so many academic and professional people around the world is overwhelming. It is a simple idea which nobody had ever thought of that can solve a lot of problems prevailing in today’s society. According to Dr. Yunus any problem can be solved by creating a business1. From this point emerged the concept of solving specific social problems through a business. It is quite understandable why this idea came from the mind of a researcher and entrepreneur of Bangladesh. Of all the countries in the world, Bangladesh is the breeding ground of a plethora of social problems. Starting from poverty to malnutrition, illiteracy, corruption, lack of human rights and safety, all these problems existing in our country can actually be solved with a business idea through the social business model.
THE SOCIAL BUSINESS MODEL
The beauty of the social business model is that it can be turned into a self-sufficient body of problem solver. This means that the business can sustain itself for a long period of time without relying on the capital from external sources. An initial startup capital is necessary to give it a push start and then it runs on its own by retaining all its earnings, provided no dividends are taken out except for the money to recoup the original capital. Thus instead of maximizing the shareholder’s wealth, the primary goal of a social business is to maximize social profit. Critics may find this model far-fetched and claim that without continuous injection of external capital it is not possible for a business to grow. However with a number of unique cost cutting techniques it is actually very much possible for the profit of a social business to grow. For example, since the target market for most social businesses is the poor and needy thus high expenditure on advertisement or publicity is not really necessary. The majority of the potential customers probably do not have enough access to media to be influenced by any sort of advertisement. Rather, door to door personal selling is a more effective as well as cost-efficient promotional tool, like the way Grameen Danone the first social business has done2. This requires strong distribution system within each small locality of the rural area where most of the target customers are concentrated.
THE CHALLENGE
I believe the major challenge the social business will face is not sustainability but raising the initial startup capital for the business. Till now most of the social businesses in the world are initiatives of the idea generator himself, Dr. Yunus. The brand name Grameen is very strong around the world now and so any business with that name will surely attract a lot of investors. Thus, so far startup investing capital was not really a problem. However, without a proper incentive of continuously growing financial return it is difficult to attract a lot of investors. If a fresh business graduate wants to start a social business, where will that young and creative mind find enough startup capital to implement his ideas and contribute towards the society? To answer this question we first need to take a peek at the different sources of capital that are available to a conventional financial profit maximization business and try to match what they have to offer to the needs of the social business model.
SOURCES OF STARTUP CAPITAL:
· Conventional Commercial Banks: Brigham and Houston (2009) called commercial banks the “departmental store of finance”3. These are the institutions that collect deposits from people and give them out as loans. Bangladesh has got more than 50 commercial banks and it is the most popular source of capital for most businesses. One reason for the popularity is probably due to the increased leverage in the balance sheet that is a window dressing technique to exaggerate the return on investment. Although this can boost up the shareholder’s wealth it will be detrimental to the social business model since investor’s personal return is not its goal. Commercial loans increase liability and with added interest to be paid it will be difficult for a highly levered business to grow without further investment from external source. This violates the self-sustaining rule of social business. Thus a loan from a commercial bank may not be the best idea to start a social business. For the very same reason debt securities like bonds or notes can also be ruled out.
· Islamic Banks: Since loans from conventional commercial banks increase debt with the pressure of interest payments, another good option can be financing with capital provided from Islamic Banks. These are also commercial banks but they follow the Sharia laws of Islam religion. The fundamental law of Sharia is that dealing with interest is prohibited. So these banks come up with unique variety of loans that does not require paying any interest rather they share both the risk and profit with the entrepreneur. Instead of becoming debtors or creditors these banks become partners in business. This minimizes the risk of diminishing growth and bankruptcy. It enhances the possibility of self-sustenance that is a requirement for social business. Out of the several products of financing available from Islamic banks two of them, Mudarabah, and Musharakah matches with the requirements of the social business model. According to Muhammad Ayub (2007) Mudarabah is a partnership arrangement in which one party (the bank) provides capital to the partnership while the other party provides entrepreneurial skills. While Musharakah is a form of a permanent equity investment, a partnership in a specific project having a fixed duration or a diminishing partnership, i.e. the bank’s share is reimbursed over time by the company4.
· Socially Responsible Investment Funds: Mutual funds are organizations that pool investors’ money and invest in various profitable portfolios of investment. This way they offer economies of scale and access to larger investment by the small investors. There are specialized mutual funds which are dedicated to investing in a particular sector. One such specialized fund is Ethical Funds or Socially Responsible Investment (SRI) funds. These are mutual funds that limit investment alternatives to securities of firms meeting certain social standards as defined by Wall Street Words (2003). However one must remember that investors who give money to SRIs do so in order to earn some extra return. Since social business models do not allow investors to take out dividends thus mutual fund portfolios will not be willing to include them. A hybrid form of mutual fund can help out in this situation. These hybrid funds were used to raise capital for Grameen Danone. They used a mutual fund where 90% was invested in traditional money market securities and the rest 10% was invested in the social business. This way investors can recover 10% of their initial investment with social profit and the rest 90% will earn them financial profit.
· Venture Capitalists (VC): Wealthy individual or organizational investors are available who are willing to invest their money for some social recognition and because they enjoy taking risks. These are called venture capitalists. They lack entrepreneurial skills but never fail to appreciate others for the same skill. They also do not wish to stick around with one business idea for a long period of time and thus try to recover their investment as soon as possible to try out another venture. According to Investopedia, venture capitalists look for a strong management team, a large potential market and a unique product or service with a strong competitive advantage5. All of these criteria match with the social business format. Traditionally a business that started with the investments from venture capitalists eventually move towards a buyout, where the ownership of the VC is transferred to the management of the company. Such buyouts are called Management Buyouts (MBO) or if loans are taken for the buyout then it is Leveraged Buyouts (LBO). For social businesses the buyout will be done through retained earnings which can be called Retained Earnings Buyouts (REBO).
CONCLUSION:
The comparative analysis above shows that commercial bank loans are not a good option to finance for the startup capital of a social business as interest payments can disrupt the self-sustainability of the business. Whereas, Islamic Banks’ partnership programs and Venture Capitalists are more suitable for a social business. Hybrid mutual funds like the one used by Grameen Danone can also be a useful source of capital. Professor Dr. Yunus had said that human beings have an inherent need to help out others. This will be the core to the success of social businesses. And so there will never be shortage of startup capital for social business. However there are people who have capital and willing to help socially but lack entrepreneurial skills and others who have risk taking ability with creative ideas but without the necessary investing capital. Through this article I tried to give some effort in building a bridge between these two groups of people.
REFERENCE:
1. Keynote speech of Prof. Dr. Mohammad Yunus in Social Business Forum 2012
2. Yunus, M; Moingeon, B; & Lehmann-Ortega, L (2010) “Building Social Business Models: Lessons from the Grameen Experience” Long Range Planning, vol. 43 pp. 308-325.
3. Brigham, E. F. & Houston J. F. (2009) “Financial Markets and Institutions” Fundamentals of Financial Management, 12th Edition pp.26-52
4. Ayub, M (2007) “Understanding Islamic Finance” Wiley Finance Publications.
5. http://www.investopedia.com/terms/v/venturecapitalist.asp
The term “social business”, which was first coined by Nobel Laureate Professor Dr. Mohammad Yunus, is now a reality in the economic world. The enthusiasm shown on this idea by so many academic and professional people around the world is overwhelming. It is a simple idea which nobody had ever thought of that can solve a lot of problems prevailing in today’s society. According to Dr. Yunus any problem can be solved by creating a business1. From this point emerged the concept of solving specific social problems through a business. It is quite understandable why this idea came from the mind of a researcher and entrepreneur of Bangladesh. Of all the countries in the world, Bangladesh is the breeding ground of a plethora of social problems. Starting from poverty to malnutrition, illiteracy, corruption, lack of human rights and safety, all these problems existing in our country can actually be solved with a business idea through the social business model.
THE SOCIAL BUSINESS MODEL
The beauty of the social business model is that it can be turned into a self-sufficient body of problem solver. This means that the business can sustain itself for a long period of time without relying on the capital from external sources. An initial startup capital is necessary to give it a push start and then it runs on its own by retaining all its earnings, provided no dividends are taken out except for the money to recoup the original capital. Thus instead of maximizing the shareholder’s wealth, the primary goal of a social business is to maximize social profit. Critics may find this model far-fetched and claim that without continuous injection of external capital it is not possible for a business to grow. However with a number of unique cost cutting techniques it is actually very much possible for the profit of a social business to grow. For example, since the target market for most social businesses is the poor and needy thus high expenditure on advertisement or publicity is not really necessary. The majority of the potential customers probably do not have enough access to media to be influenced by any sort of advertisement. Rather, door to door personal selling is a more effective as well as cost-efficient promotional tool, like the way Grameen Danone the first social business has done2. This requires strong distribution system within each small locality of the rural area where most of the target customers are concentrated.
THE CHALLENGE
I believe the major challenge the social business will face is not sustainability but raising the initial startup capital for the business. Till now most of the social businesses in the world are initiatives of the idea generator himself, Dr. Yunus. The brand name Grameen is very strong around the world now and so any business with that name will surely attract a lot of investors. Thus, so far startup investing capital was not really a problem. However, without a proper incentive of continuously growing financial return it is difficult to attract a lot of investors. If a fresh business graduate wants to start a social business, where will that young and creative mind find enough startup capital to implement his ideas and contribute towards the society? To answer this question we first need to take a peek at the different sources of capital that are available to a conventional financial profit maximization business and try to match what they have to offer to the needs of the social business model.
SOURCES OF STARTUP CAPITAL:
· Conventional Commercial Banks: Brigham and Houston (2009) called commercial banks the “departmental store of finance”3. These are the institutions that collect deposits from people and give them out as loans. Bangladesh has got more than 50 commercial banks and it is the most popular source of capital for most businesses. One reason for the popularity is probably due to the increased leverage in the balance sheet that is a window dressing technique to exaggerate the return on investment. Although this can boost up the shareholder’s wealth it will be detrimental to the social business model since investor’s personal return is not its goal. Commercial loans increase liability and with added interest to be paid it will be difficult for a highly levered business to grow without further investment from external source. This violates the self-sustaining rule of social business. Thus a loan from a commercial bank may not be the best idea to start a social business. For the very same reason debt securities like bonds or notes can also be ruled out.
· Islamic Banks: Since loans from conventional commercial banks increase debt with the pressure of interest payments, another good option can be financing with capital provided from Islamic Banks. These are also commercial banks but they follow the Sharia laws of Islam religion. The fundamental law of Sharia is that dealing with interest is prohibited. So these banks come up with unique variety of loans that does not require paying any interest rather they share both the risk and profit with the entrepreneur. Instead of becoming debtors or creditors these banks become partners in business. This minimizes the risk of diminishing growth and bankruptcy. It enhances the possibility of self-sustenance that is a requirement for social business. Out of the several products of financing available from Islamic banks two of them, Mudarabah, and Musharakah matches with the requirements of the social business model. According to Muhammad Ayub (2007) Mudarabah is a partnership arrangement in which one party (the bank) provides capital to the partnership while the other party provides entrepreneurial skills. While Musharakah is a form of a permanent equity investment, a partnership in a specific project having a fixed duration or a diminishing partnership, i.e. the bank’s share is reimbursed over time by the company4.
· Socially Responsible Investment Funds: Mutual funds are organizations that pool investors’ money and invest in various profitable portfolios of investment. This way they offer economies of scale and access to larger investment by the small investors. There are specialized mutual funds which are dedicated to investing in a particular sector. One such specialized fund is Ethical Funds or Socially Responsible Investment (SRI) funds. These are mutual funds that limit investment alternatives to securities of firms meeting certain social standards as defined by Wall Street Words (2003). However one must remember that investors who give money to SRIs do so in order to earn some extra return. Since social business models do not allow investors to take out dividends thus mutual fund portfolios will not be willing to include them. A hybrid form of mutual fund can help out in this situation. These hybrid funds were used to raise capital for Grameen Danone. They used a mutual fund where 90% was invested in traditional money market securities and the rest 10% was invested in the social business. This way investors can recover 10% of their initial investment with social profit and the rest 90% will earn them financial profit.
· Venture Capitalists (VC): Wealthy individual or organizational investors are available who are willing to invest their money for some social recognition and because they enjoy taking risks. These are called venture capitalists. They lack entrepreneurial skills but never fail to appreciate others for the same skill. They also do not wish to stick around with one business idea for a long period of time and thus try to recover their investment as soon as possible to try out another venture. According to Investopedia, venture capitalists look for a strong management team, a large potential market and a unique product or service with a strong competitive advantage5. All of these criteria match with the social business format. Traditionally a business that started with the investments from venture capitalists eventually move towards a buyout, where the ownership of the VC is transferred to the management of the company. Such buyouts are called Management Buyouts (MBO) or if loans are taken for the buyout then it is Leveraged Buyouts (LBO). For social businesses the buyout will be done through retained earnings which can be called Retained Earnings Buyouts (REBO).
CONCLUSION:
The comparative analysis above shows that commercial bank loans are not a good option to finance for the startup capital of a social business as interest payments can disrupt the self-sustainability of the business. Whereas, Islamic Banks’ partnership programs and Venture Capitalists are more suitable for a social business. Hybrid mutual funds like the one used by Grameen Danone can also be a useful source of capital. Professor Dr. Yunus had said that human beings have an inherent need to help out others. This will be the core to the success of social businesses. And so there will never be shortage of startup capital for social business. However there are people who have capital and willing to help socially but lack entrepreneurial skills and others who have risk taking ability with creative ideas but without the necessary investing capital. Through this article I tried to give some effort in building a bridge between these two groups of people.
REFERENCE:
1. Keynote speech of Prof. Dr. Mohammad Yunus in Social Business Forum 2012
2. Yunus, M; Moingeon, B; & Lehmann-Ortega, L (2010) “Building Social Business Models: Lessons from the Grameen Experience” Long Range Planning, vol. 43 pp. 308-325.
3. Brigham, E. F. & Houston J. F. (2009) “Financial Markets and Institutions” Fundamentals of Financial Management, 12th Edition pp.26-52
4. Ayub, M (2007) “Understanding Islamic Finance” Wiley Finance Publications.
5. http://www.investopedia.com/terms/v/venturecapitalist.asp