How to value social enterprises

By Acumen on March 03, 2008

When Acumen Fund thinks about making an investment in a social enterprise, we start like a traditional venture capitalist might: what is the idea?  What kind of market will it serve? How do you scale the business? What is the potential exit from the investment? Unlike a traditional VC, however, the harder the market to serve, the poorer the customer, and the bigger the social need, the more excited we get about the ventures. We are also very clear that we want to support innovative business models, not just ones that can maximize our financial returns, but ventures that can demonstrate new models and help prove that in some cases, market-based approaches work to serve the poor. 

Our analysis always starts at the unit level: what is the product or service? Who are the customers? What are the costs to serve?  How do you make money?  How do you beat the competition?  Any good analysis is clear on the assumptions at the unit level and builds up from there. If one hospital or ambulance or housing development can’t return the cost of capital over three to five to seven years, it’s not quite clear to us the value in scaling the business. We also look at the relative social impact compared to the Best Alternative Charitable Option, are clear about the risks, think about the team and their alignment with our mission and values, and what value Acumen Fund brings to the table.

All of this helps us make a decision about whether we want to support a business, but doesn’t determine what we should pay for our share of the company. Say we want to invest $1m in a network of private hospitals in East Africa that target the poor.  The hospitals will hit break even with a 60% occupancy rate in 14 months. The detailed financial pro formas show significant cash flows after year three as the model hits critical mass. We like the idea, we love the team, it’s now time to make a deal. What to offer?

Venture investing, as our investment committee (comprising several members of our board) likes to remind us, is more art than science. Social venture investing takes that art to a whole new level. What discount rate should we use to value the cash flows? Standard venture capitalists use 30%, but often use a rate of 35 or 40% in emerging markets. Should we go even higher because we are serving riskier customers in these risky markets, or should we have a social discount because these investments need our patient capital? If so, how low should we go? What assumptions should we use about how we exit? There aren’t many comparables that we can use to benchmark the company’s financial value: what should the price to earnings ratio of a private ambulance company be in Mumbai in 2012? Finally, many VCs will determine the valuation by their own required hurdle rate. Acumen Fund, using philanthropic capital to make venture investments, has no hurdle rate. Our obligation is to support innovative businesses and share lessons with the world, that’s our cost of capital. 

In all of these discussions, we also have to keep the customer front and center. How do we do the analysis in such a way that doesn’t overlook the end consumer, simply aggregating daily challenges into quarterly revenues, clinical outcomes into network performance, and individuals touched into market share. We are talking about real lives, real problems, and real solutions. Our discussions try to balance our need for fiduciary responsibility with the empathy that drives us to support businesses that were designed to serve the poor. 

In the end, we do what other venture investors do, with perhaps a softer touch. We try to get the best deal we can, we try to treat the entrepreneur and his or her management team fairly, we anticipate the future capital needs of the company and what more commercial investors might expect in a valuation, and we benchmark the investment with the rest of our portfolio. In the end, we’ll make an offer that we think stands the best chance of building a sustainable enterprise that can serve the poor with a deal that has the best chance of returning the capital to Acumen Fund. With each investment, we hope to prove our model and give ourselves the chance to start the process all over again. So how should we think about valuing that chain of toilet facilities in the slums of Nairobi?

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