Barriers to Foreign Funding for Social Entrepreneurs
Dr. Akhil Shahani
Sunita runs a small-scale enterprise that trains rural women to weave traditional fabrics and then buys their output. She needs to raise funds for working capital needs and market expansion.
She does not have any collateral to offer and can only provide below-market returns on the funds raised. She contacts Evelyn, who is the manager of a US-based impact fund that has the mandate to support traditional artisans in Asia. Evelyn has already successfully funded social enterprises in South East Asia but faces a challenge supporting Sunita in India.
If Evelyn wants to give grant funding, Sunita would need to have a non-profit company (under section 8 of the Income Tax Act) or a charitable trust which needs to have an FCRA (Foreign Contribution Regulation Act) certificate. Even if Sunita wanted to set up a non-profit entity, she would need to run it for at least three years and spend at least ₹10 lakh ($12,500) on its objectives before she can qualify for the FCRA license.
If Sunita wanted to raise equity investment from Evelyn’s fund, she would have to provide a detailed business plan showing how the company can grow and ensure a profitable exit for equity investors. She would also need to go through a due diligence process to ensure all her compliances and paperwork are in order. Sunita may not have the administrative resources to go through this process and may even fail to raise equity investments at the end of this due diligence process.
Raising debt is also a challenge.
The RBI allows Sunita to get a loan from abroad under FEMA (Foreign Exchange Management Act). However, she can only issue Non-Convertible Debentures, which require her company to have a net worth of at least ₹4 crore ($500,000) and cannot be for more than a term of 3 years. In addition, she cannot provide an interest rate that is below the market rate.
This fictional example illustrates the challenges faced by international impact investors who want to fund social entrepreneurs in India. However, new models of Blended Finance could solve some of these funding issues.
Blended finance is a way to structure investment with minimal or below-market returns into social enterprises.
Usually, these structures combine two or more funding organizations like ESG focused venture capital funds, debt funding providers, grant-making foundations and government development financial institutes. Each entity contributes funds based on its own risk/return expectations, with the combined pool of funds being available at rates much lower than market returns.
Some blended finance options include models like subordinate debt (an unsecured loan that has a lesser claim on assets/earnings than regular debt), first loss equity (an equity investment which will bear the first economic loss in case of default) and returnable grants (zero interest non-collateralized loan that can be paid as per the capacity of recipient). Results-based financing, in the form of Impact Bonds, etc. where the payment is made on achieving predetermined outcomes is a unique model that has started to gain traction in India. The government has also mooted the idea of a Social Stock Exchange which allows nonprofit organisations to raise funds via unique models.
Hopefully, government regulators will become more aware of the importance of self-sustaining social enterprises in helping to uplift the lives of millions of Indian citizens and will create an enabling environment to help them access much-needed financial help from their international supporters.
Dr. Akhil Shahani
Akhil is the Managing Director of The Shahani Group. He runs SAGE Foundation, which helps thousands of low-income youths gain white-collar jobs, and Unltd India, a prominent incubator for startup social entrepreneurs that has supported many craft-led enterprises as part of its portfolio. He is an active investor with a keen interest in social impact and entrepreneurship.