What are the specifics of financing stewardship ownership? Why does conventional equity financing not suit steward ownership?
Financing of steward-owned companies
Summary
Various ways enable steward-owned companies to distribute liquidity to investors without compromising the company's independence and sense of purpose. In contrast to conventional ways of raising liquidity, many of these methods require longer investment periods. More and more investors recognise the importance of "patient capital" for the long-term value creation and impact of a company and are therefore willing to tie up their capital for longer.
Why conventional equity financing is not a good fit for steward-ownership.
Like all companies, steward-owned companies reach stages in their development where they require investment capital to grow and develop their business. To achieve this, the owners of a steward-owned company need instruments that are suitable for them and that address the special needs of steward-ownership. Conventional equity financing is rarely suitable for steward-owned companies.
First, let us consider the start-up context: the venture capital ecosystem and its financing tools are not designed to sustainably finance mission-driven companies. The whole start-up funding system is based on injecting large amounts of capital to grow a business so that it can be sold in a profitable exit or IPO.
Due to the high failure rate of startups, these instruments are designed to produce returns of at least 10x and more from successful investments. In addition, the term-sheets used for those investments often give investors far-reaching minority rights. One example is the “drag- along” right. Drag-along rights give investors who are interested in selling an investment the right to force the other owners, including the founders, to join the deal. Obviously, this can undermine the social or environmental mission of the underlying company, but that’s a secondary concern to the investor – and the financial objectives of investors are given more weight than the purpose of the company itself.
For companies seeking to prioritize long-term sustainability and multi-stakeholder engagement, these capital structures are often outright incompatible.
Mature companies face a similar challenge. Without access to long-term, patient capital, these businesses are often forced to sell to private equity firms or go public in order to provide investors, founders, and employees with liquidity. Private equity firms make money by cutting costs, maximizing profits, and ultimately reselling companies to other firms, where the cycle continues. It is very difficult for any business to stay committed to its values and mission in this model. And companies face similar challenges on the public market, where quarterly earnings reports, speculative investors, and activist shareholders demand businesses prioritize short-term earnings over long-term mission and strategy. Going public and selling all but guarantees a company is forced to prioritize shareholder value over its mission and the interests of its other stakeholders.
To sum up, conventional financing tools rarely work for social enterprises or steward-owned companies, because:
- Excessive return expectations lead to unrealistic growth trajectories, and leave viable businesses (that cannot become “unicorns”) without funding;
- Equity financing with preferred shares is often designed so that investors gain as much control over a business as possible; and
- Selling shares to private equity investors or on the public market strips businesses of their independence and forces them to prioritize shareholder value over mission.
These financing tools contradict the principles of steward-ownership, compromising business’ independence and any mission-oriented perspective on profits.
Clearly, conventional equity-based financing structures often contradict the principles of steward-ownership and jeopardize the independence of companies as well as any strategy that is not primarily focused on profit maximization
The problem is further compounded by the fact that even impact investors are likely to seek similar terms when funding social enterprises. While impact investors often share a social outcomes goal with founders, they frequently fail to realize the implications of those goals for a company’s financing structure. That is why we often see- impact investors seeking similar returns on similar terms and timelines as venture capital and private equity investors.
Fortunately, there are viable alternatives to conventional financing, and a growing community of investors and entrepreneurs who are leveraging them to support steady growth and balance the impact of their business with returns to investors. We will take a detailed look at the different options available for financing existing and prospective steward- owned companies.
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- Audio: Achim, co-founder of Purpose Ventures @Ragnarson Invest Podcast
- Video: Aunnie Patton-Power, Author of Adventure Finance, speaks about a funding journey that blends profit and purpose
- Video: Alternative Finance &Steward-Ownership – Workshop at SO:22
- Article: Esme Verity of Considered Capital on SO-aligend financing
Published by: Purpose Schweiz
Graphics and illustrations: Purpose Stiftung