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Washington DC - Relay Foundation

Washington DC

WH

Washington DC

At the Base of the Brain

Overall Trends:


DC is working to become one of the next great startup cities like Silicon Valley, New York, and Boston. Good for them, too, because they have all the things you need to build a strong startup community. They have a rich density of powerful networks, great universities to get the new generation of entrepreneurs, and access to a global network of on-the-ground workers, support organizations, and financiers. When you take a look at social entrepreneurship in DC, however, it lacks density, and this is really slowing down the growth of the space. Density is hugely important for building communities; you need lots of people with lots of interests working together in order to have a sustainable impact. The fewer people and organizations involved or the more spread out those people are, the harder it becomes to build the lasting relationships necessary for a social startup to grow. Distance kills.

For me, DC is like that kid in school that knew absolutely everyone. They were always stopped in the halls by the jocks, the popular group, and the math geniuses and they always knew who you should talk to in order to do what you want to do. For those who are a bit more removed from school, DC is the ‘Connector’ from Malcolm Gladwell’s book, ‘Tipping Point’. DC has groups like Agora Partnerships, Aspen Institute,Lex Mundi Foundation(and under it Law For Change), as well as service providers like the William James Foundation and Affinity Lab. Nearly all of the major players have been in the space for over a decade and they have the experience and connections to put those networks to use. They know people, and that is just awesome. But almost all of these service providers have a mission to help anyone on the planet, no matter where they may be.

So let’s take a look at this from the entrepreneur’s perspective. In today’s social entrepreneurship space, you have a few options when it comes to the types of companies you can build. The first option is social technology, and it is very seriously on the rise. Apps that help people better spend their money or that help farmers learn the fair market prices for their crops are taking off. But you can build these apps and technology anywhere, and so DC isn’t very attractive when you compare it to New York City or San Francisco. The second option is to build an actual product and that means (if you want to keep transportation costs low) manufacturing space, housing a team, and having access to many types of capital. DC doesn’t have these puzzle pieces to the level a stable social entrepreneurship community would need, so that’s out too. The last option for a startup is to provide a service, and that means being in contact with the person you are servicing. If you aren’t servicing a DC population, then again DC holds little draw.

Now let’s take look at the perspective of the serviceproviders, groups likes incubators and accelerators, as well as universities and mentors. DC at present has no real centralized ’cause’ or type of startup. New York has Ed-Tech now that BigApps and TechStars/Kaplan have moved in. Boulder has sustainability and agritech. Boston has an emphasis on developmental technologies through MIT and Harvard. DC doesn’t have something like that to that extent. They are making headway towards the tech scene with 1776, a recently opened incubator and accelerator space, and Georgetown’s business plan competition. But for a serviceprovider that wants to make money, there isn’t an industry-specific service they can provide outside of the standard startup infrastructure like office space. This leads to the chicken-and-egg problem. Startups with industry-specific needs don’t go to the city because the city doesn’t have the necessary infrastructure, and then the city doesn’t provide the service because there isn’t enough of a market to survive. Solving this problem means building an industry-specific social startup space in DC and that would be just awesome.

This generalization of services has a deeper implication on finance as well. You see, startups that don’t get the services they need right when they need them tend to fail. Heck, even startups that do get what they need tend to fail. But this generalization of services leads to the social startups that do get going in DC end up not having what they need more often than not and this increases their chances of failure. I don’t have the numbers now, and frankly I don’t know if they exist, but I would love to see the relative rate of failure for social startups in cities that having thriving, industry-specific social startup services versus those of cities that don’t. Anyway, I would argue that the lack of a strong support system means failure rates are higher and makes the angels and other finance bigwigs play a bit more conservatively. In standard entrepreneurship communities, this means early-stage companies social or otherwise, have a harder time getting money and this further delays the development of a solid, thriving startup community.

Now I don’t want to dog on DC the whole time; but the question has to be asked: What does DC offer social startups? That’s easy. DC has some of the largest service providers, networks, foundations, and policy organizations in the nation, possibly the world. And perhaps DC isn’t meant to be a majorly social startup community; perhaps helping others get access to DC’s connections, power and policy is its role. If that is indeed the case, then DC really needs to figure out how to structure its networks and the like in such a way that social startups and their need of alternative financing (which I will discuss below) are on equal grounds to compete with startups that can pick up VC or other Equity funding. This is another conversation entirely, and I think we’ll have more information after New York!

How It All Answers Question 1: What is Social Enterprise Around the World

I have a gift for you! Follow these three simple and easy steps to frustrate anyone in DC that is linked to traditional social enterprise and charity work (that includes you too, foundations!). Step one: find a anyone linked to traditional enterprise or charities in the city. Step two: tell them you think social enterprises should make money for the social impact they have. Step three: duck and cover.

Ok, jokes aside, there is a massive gap in belief between the traditional social impact space and social for-profit entrepreneurs. From what I’ve seen, this gap is tangible in DC, with a handful of strong startups bucking the trend. The gap that I’m talking about is the fight over whether charities can solve all the world’s problems with standard existing business models and potential hybrids, and if the current market relationship, where the for-profits make the money and the non-profits ask for money to clean up the mess, can last much longer. One guess on where Relay falls on this point (Hint: We exclusively serve for-profit social startups). This gap in understanding and belief manifests in two major ways. First, charities that try to charge for their services are attacked as being bad at what they do. How dare they charge to help people?! This argument is slightly absurd as it seems to assume charities operate without costs (and don’t even get me started about people getting mad when Executive Directors of charities make the market rate for their position). Relay is a charity and, let me tell you first-hand, there are some massive costs. Second, social for-profits are expected to ignore basic market principles like supply and demand because the impact is supposed to be more important than the money. To this I have one question, how much impact can you have when you go out of business? The two need to be equal.

Please please please, do not hear me saying that charities are not useful. They are amazing. But to say that all social causes in all situations need to be solved by charities is taking it far too far. Charities are legally situated to solve certain issues more efficiently than for-profits, social or otherwise. Even more, the rise of social for-profits has within it the opportunity to reduce the stress on charities in terms of served populations by helping those not so in need of the charitable services and advanced technologies (Causecast, for instance) to maximize charitable capacity. Charities and for-profits should actually be working together to leverage the benefits of their legal structures, networks, and programming to maximize their social impact, much like you see happening in New York and San Francisco. If DC wants in on this trend towards deeper social impact there needs to be more education offered that helps people holistically understand the social space in all its randomness and splendor. Or send them to Relay. We rock.

I should make a mention of an organization that has found a nifty little hybrid legal structure that has allowed it do build traction and impact by leveraging standard for-profit and nonprofit principles like those I mentioned above. The business is called Cause, and is a bar that donates 100% of proceeds to charities, as well as sources beers and wines from organizations that do the same. The interesting bit about Cause is how they inspired local investors to get involved financially. Cause split into two entities, the charity side that passes on the donations, and the for-profit side that owns the property. Investors didn’t put money into the Bar, they put it into the property. This means they don’t need to worry about the charitable causes of the bar so much because the piece of land doesn’t change value based on the bar’s successes or failures.  Now, this alone wouldn’t meet the standard of a social enterprise in our book because the model is (Organization giving Profits to Charities), but the extra something is the sourcing. Cause gets a lot of its drinks from organizations that donate some of their profits, focus more on the quality of life for their workers, and at times even make their drinks with solar energy. Cause has a holistic understanding of every step of their business, and for that I think they get the Social Enterprise badge. The founders are all brilliant, so I recommend getting a pint if you’re in the area!

A wall of recycled beer glasses with the backlight shining bright.

How It All Answers Question 2:

How to Best Get People Into the Space and Keep Them Interested

I don’t think many people will disagree with me if I say that people get involved with causes and movements that help them be who they want to be and help them do what they want to do. Once they’re in, you keep them there by building a lively and engaging community that can sustainably supply meaning and tools to those within the community. There are a few big leftover questions but because of the role DC currently plays in the social startup space, it doesn’t really have to deal with them. DC, with networks on the global level, instead has been able to discover something that smaller networked communities don’t have the time or resources to: how to distill a large amount of information from a massive institutional network in order to get the best of the best of the best people involved with the development of the entrepreneurs that come looking for help.

Take The William James Foundation, for instance. Ian, the Executive Director, has been able to source a professional collection of over 800 judges to provide over 20 pages of feedback to social entrepreneurs that advance through the WJF Competition. So the 500+ applicants each year end up leaving with an understanding of what they should learn, who they should talk to, and what steps they should take next in order to take their ventures to the next level. WJF in effect provides a map and a collective worldview of what is possible if the entrepreneur intends to move forward.

The attribute that best defines WJF’s success, I should highlight, is not its mentors but that it is so damned deliberate. If I were to pair a greentech startup with someone who has no idea what greentech even is, what good would come of it? Now what if I instead paired that greentech startup with a professional in the greentech field? Then I did a better job and might deserve a cookie. But WJF goes even further, almost reaching the point of fanatical care, to even looking to the demographic information of the applicants, their market, the everyday facts of their lives. Judges are paired with startups based on factors like if both the mentor and the founders have kids, or if they live in the same area, or if they went to the same school. Taking these points into considerations helps take the feedback from just some notes to instead a tried-and-true path forward for mid-stage social startups. I could take up ten more pages talking about WJF’s process, but for now just remember: the social sector has scarce resources and the high-quality people we need have many other options to be successful; for everyone involved, you have to be deliberate in using those resources to bring the right people into the space in the right way if you want them to stay. Rather than letting everyone into the space the same manner, we have to personalize and adapt our strategies to ensure the newer practitioners are set up for success, otherwise they may leave with a bad taste in their mouths and never come back.

Think of it like a Statement of Work (SOW). In Human Resources, a SOW is the list of things that are going to be expected of you and what you will get in return for doing them. If don’t give an accurate Statement of Work the new hire is going to run away. Same thing for the social startup space. If you tell people you are going to give them awesome mentors, make sure they’re actually awesome. Trust us, it will go a long way and make everyone’s life a lot easier.

Ian Fisk (ED, The William James Foundation) addressing a collective of global changemakers.

How It All Answers Question 3:

How to Structure Finance in a Way that Helps Social Startups

Financing startups is risky. That’s the entire point. You need founders that align with each other, you need the founding team to align with the investors, and you need the startup to align with the market. It’s hard and a lot of people fail at it. That’s fine, though. That’s how we learn.

A social startup adds one more level of complexity in that there is an ethic in play. If you think a college education today is terrible for the price, you’re saying that the price should either come down, the quality of instruction should improve, both, or we should just do away with college altogether. Those three options, even though they could lead to the desired outcome, that of a more worthwhile education, can serve as a point of contention within the startup team. One person may say the education price should come down because otherwise only the wealthy would be able to use their solution. Others may say the quality should improve because, if the wealthy can afford it, why should we deny them a product they want? So you see, even with the desired goal to improve education, you have a many ethics that at time conflict. And this is without counting the investors!

This piece won’t address that issue, but I intend to soon (How terrible am I to drop that and walk away? So evil I am). This piece instead will touch on one major financial trend that anyone getting involved with social enterprise needs to know. The thing is, social startups have a different development timeline than most other startups. Tech startups, for instance, cost very little to make, little to test, and little to scale (and yes I am saying $1.5 million is ‘little’). They can take on Venture Capital and Equity funding because they want to get as big as possible as fast as possible. Standard manufacturing has access to debt they can take from a bank and still have access to equity funding and the growth factor is likewise key. Social startups on the other hand, because of their social nature (either creating markets, providing time-intensive services, or other similar cost-creating/time-consuming operations), tend to remove the option for explosive growth, take longer to reach scale and therefore often do not fit the VC model.  This means they have a hard time getting access to pivotal funding that could make or break the company. There is also the assumption amongst standard and institutional investors that being a social venture almost inherently means having smaller profits and a smaller return on investment, which further constricts the capital pool open to social startups.

The trend that I am going to talk about is finance guys and girls offering loan-based finance rather than equity to social entrepreneurs. The two major types I want to talk about are Royalty-based Investment (RBI) and Convertible Notes. RBI works like this: you give a startup a some money and in return they give you a percentage of their revenues for a period of time. Whereas equity takes a part of the company and makes a profit after a long period of time passes and there is an exit (when another company buys the startup or the startup goes public and offers shares), RBI takes a percentage of the cash right away. Startups can even offer things called Warrants to investors, which allow investors to buy equity if the startup ever offers it. This helps investors a bigger win if the startup becomes massively successful. Presently, most investors providing RBI to startups deal with companies already bringing in over $1 million in annual revenue (still sort of small if you think about it). Not to sound too crazy, I am starting to think that this type of financing could work as a form of concessionary capital for early-stage social enterprises with large addressable markets. Concessionary capital is money from investors where they accept they aren’t going to make the market rate of return but are ok with it because the social impact is worth the loss in profit. The fact that a percentage of revenue is taken means the investor and the founders are looking to do the same thing: increase revenues. If the startup gets all its money from doing social good, then that means the investor is aligned with the mission without even thinking about it! Credit Suisse has done some work on the idea, and I will bring updates as we learn more.

The other option for capital is a Convertible Note (CN). A CN is a loan with equity-like attributes and a hard-stop. A hard-stop is a point in time when the startup has to pay back the loan in full plus interest. CN are good for investors because they allow the investor to convert the note into a specified number of shares of common stock in the event the startup goes public, often more than they would be able to attain when they write the note. They’re good for startups for a number of reasons ranging from the speed of completing the documents to the relatively lower cost to their company compared to equity. Getting rid of the legalese, a CN helps the startup founders keep their company to themselves and helps them get the money faster than if they wanted investment.

Simply put, these two options of RBI and Convertible Notes allow social startups a way to scale outside of the pure VC route that most social startups don’t fit.

Let me be clear, because social startups exist in an underdeveloped financial world, these two options are incredibly important. Impact Engine out in Chicago uses convertible notes almost exclusively because it just makes sense for a social startup’s timeline. When I say underdeveloped, I mean to say that standard startups know the financial field. It’s predictable. Most everything is stable and if you were to throw a rock down the street you would hit someone who could give you a term sheet (at least in San Francisco). For social startups, there is more chaos. The models are changing, the venture’s growth is often not explosive, and the investor community hasn’t quite locked in how to value social impact. There are new financial models each day in the form of concessionary capital, venture philanthropic or standard market finance. Yes, this creates confusion on the best way to bring in financing for your social venture, and there needs to be some light shown in on the darkness (Hint: Relay Foundation is pretty good at this).

Oh well. I’m rambling now, but we’ll go further into the social finance world as the pieces continue to roll in.

Some of our new friends from American University’s Social Enterprise Program. The coffee was delicious!

 

Bruce Wilson,

Founder