Catalytic capital in action: Four lessons learned from the ESIIF

The European Social Innovation and Impact Fund (ESIIF) uses catalytic capital to enable better access to finance for early-stage social enterprises. But how exactly do the catalytic and innovative components create additionality? In our case study, we reflect upon the design elements of this unique fund and list the top 4 lessons we have learned so far.

Photo: © Anders Jilden / Unsplash

First, some ESIIF facts and figures:

At FASE, we initiated the ESIIF as the second pillar in fulfilling our mission to create a thriving European ecosystem for social innovation. Designed as an impact mezzanine fund, the ESIIF is the first of its kind in Europe and enables better access to finance for early-stage social enterprises. But before we dive into the details of the Fund’s catalytic and innovative components, some facts, figures and definitions:

What is catalytic capital? The Catalytic Capital Consortium (C3) describes this type of capital as follows: “Catalytic capital—investment capital that is patient, risk-tolerant, concessionary, and flexible—is an essential tool to support impact-driven enterprises and organizations that lack access to capital on suitable terms through the conventional marketplace. The aim of catalytic capital is to unlock impact and additional investment that would not otherwise be possible, strengthening communities, expanding opportunity and economic growth, and fueling innovation that advances the well-being of people and the planet, while laying the groundwork for mainstream investors to participate in transformative investments.”

About the ESIIF:

  • Type of organisation: The European Social Innovation and Impact Fund GmbH & Co. KG (“ESIIF”) is an impact fund domiciled in Germany and set up as a closed-end “Spezial-AIF” according to German §2(4) KAGB. It is available to professional and semi-professional investors in Germany. The final closing took place in 2022.
  • The financial instrument(s) used: The ESIIF makes mezzanine investments into social enterprises in the size of EUR 100k to 500k per enterprise and with a tenure of a maximum of 8 years. Each investment matches 1:1 the financing amount that the enterprise raised from direct investors (matching fund principle).
  • The beneficiaries and impact sectors targeted: The direct beneficiaries of the ESIIF are social enterprises as defined by the European Union and based in an EU member country. They need to meet the criteria of the EaSI Guarantee that the ESIIF has embedded as a catalytic component. The ESIIF is agnostic in terms of impact sectors and pursues a broad diversification across sectors.
  • Country focus: The ESIIF targets social enterprises in all EU member countries, with a preference for Germany (min. 51%), Austria, and the Benelux region.
  • SDGs addressed: Potential ESIIF investees can cover the entire spectrum of SDGs. The ESIIF itself “pays into” SDG 17.

The market challenge and how we meet it

The motivation to design and initiate the ESIIF came from 10 years of first-hand experience with the stumbling blocks that early-stage social enterprises are facing when trying to raise capital. This is why we reached out to avesco financial services to partner with us and act as the Fund’s manager. The ESIIF applies a novel approach by using the “EaSI Guarantee” provided by the European Investment Fund (EIF) as a derisking mechanism for a portfolio of around 60 social enterprise investments. Together with other features, such as the layered fund structure that offers investors a choice between senior and junior tranches, this derisking mechanism helps to address the systematic financing gap, often called “missing middle”. Designed as a passively managed matching fund, the ESIIF matches the commitments of one or several direct investors, provides mezzanine capital and builds a broadly diversified portfolio. Here is a short summary of the core design elements:

On top of the catalytic structure of the ESIIF, there is also a strong non-financial support component in place: All eligible social enterprises need to enter into a transaction support mandate with FASE, which boosts capacity-building, investment readiness and access to potential direct investors. This includes:

  • Know-how transfer and guidance throughout the entire transaction process, including investment readiness support (review of financing strategy, business model, suitable investor types and coalitions, preparation of investor materials and impact logframe)
  • Connections to a pre-selected list of suitable, potential direct investors out of the entire FASE network
  • Deal structuring support and expertise
  • Moderation of negotiations between potential direct investors and the social enterprise founders

The impact logic and what we have achieved to date

To address the missing middle, the ESIIF measures several indicators. Here is what we have achieved as of January 2023:

  • Amount of fund commitments raised from investors: EUR 12.43 million
  • Number of social enterprises financed: 13
  • Amount of financing provided to social enterprises: EUR 4.65 million
  • Amount of additional capital catalyzed from direct investors: EUR 13 million

In addition, the following qualitative and catalytic contributions to improving the social enterprise finance ecosystem could be observed since the ESIIF took up its investment activity in Q1 2021:

  • The ESIIF has become a major component in the investor coalitions of the financing rounds of its target social enterprises and a success factor in bringing these rounds to a close.
  • The ESIIF allows social enterprises to raise more capital to scale their impactful solutions.
  • The ESIIF allows social enterprises to close their rounds more quickly.

The top 4 lessons we have learned to date

While it’s still relatively early in the Fund’s lifecycle, the ESIIF has provided us with a plethora of learnings. Here are “just” the main ones:

Design & structuring: The process from the first idea to the successful implementation of the ESIIF proved to be very time-consuming. The decisive component was the EaSI Guarantee from the EIF, which we secured in 2020. Without this derisking mechanism, raising sufficient capital for the ESIIF to enable better access to finance for European “missing middle” social enterprises wouldn’t have been possible.

Investor appetite & preferences: Throughout the process, it became evident that 85% of impact investors are still seeking at least market-rate returns (as famously reported by the GIIN each year). Put differently: The efforts from many market actors and us to mobilize more concessional capital and “investors for impact” weren’t successful enough to date. Thus, catalytic capital continues to be crucial, whether in the form of risk mitigation or return enhancement.

Market conditions: As the market environment continues to be in crisis mode, the challenges for social enterprises increase since investors have become more cautious. It is very positive that the ESIIF is well-positioned to be a reliable financing partner in such a challenging fundraising climate. Also, the matching funds provided by the ESIIF can shorten the time for social entrepreneurs to close a round. As a result, there is a lesser risk that time-consuming fundraising efforts will divert founders too much from pivoting business models and/or adapting to new market environments.

Financial instrument: By using mezzanine capital, the ESIIF avoids some disadvantages of equity and debt from the perspective of the investees. Instead, the fund provides patient capital with a tenure of up to 8 years. Using mezzanine capital also has benefits for the Fund’s investors: As a self-liquidating instrument, mezzanine makes the fund less dependent on favourable exit markets.

Are you curious to hear more?

For deep divers, here are some additional resources on the ESIIF: