Entrepreneurs are not short of challenges as they navigate start-up runways and product road maps during the early stages of their venture, especially as anything from 75 to 90 per cent fail within five years.
But another significant challenge for entrepreneurs, especially in the absence of an established trading record, is the ability to demonstrate the value of an innovative new business to the various stakeholders essential to its success.
The challenge to demonstrate value, often beyond that of traditional core financial statements, is not confined to entrepreneurs; it is an increasingly common problem for established business. A survey by communications giant Edelman revealed that 96 per cent of US investors expected to increase their focus on environment, social and governance (ESG) factors as an investment criteria post-pandemic. Whether it is consumers, suppliers, regulators, investors, or other stakeholders, regular for-profit organisations are under greater pressure to show a positive net impact on society.
Together with my colleagues Emily Barman, of Loyola University Chicago and Matthew Hall, of Monash University, we set out to investigate how an organisation could convey to stakeholders concepts of value beyond the boundaries of conventional financial reporting. To do this we turned to an instructive example, the pioneering San Francisco-based philanthropic venture, the Roberts Enterprise Development Fund (REDF), which coped with a similar challenge two decades ago.
In the late 1990s, REDF planned to invest in, launch and grow social enterprises focused on providing employment training and opportunities. This required the staff at REDF to justify using a relatively new type of organisational form – the social enterprise.
They needed to create confidence that this type of for-profit vehicle was suitable for fulfilling a social purpose, in this case improving the lives of chronically unemployed individuals. Their success in convincing stakeholders was largely due to their creation of the now widely adopted Social Return on Investment (SROI) accounting approach.
Following an in-depth study into the development of SROI at REDF, including interviews with several people instrumental to its invention and use, we identified three activities key to developing innovative accounting systems to demonstrate value to stakeholders.
The aim of imagining is to make an educated guess about what stakeholders want to see, hear and will be receptive to. Do they prefer numbers or words? Do they want numbers that refer to money or to other inputs, like surveys, for example?
While stakeholders may be able to help with this process, our research suggests they may not know or be able to articulate what they want. Nor, in the case of entrepreneurs and new ventures, may they have the time or inclination to engage, given the likely power differential.
Identifying relevant target stakeholders is often relatively straightforward. Imagining how to persuasively communicate the benefits of the enterprise to this audience is likely to be more difficult though.
In the case of REDF, the breakthrough came when the staff imagined that, rather than describing outputs of the enterprise, such as services provided or people hired, the philanthropic investors and donors would prefer social value to be framed in the language of investment. The solution - express social impact value as the economic and social returns in excess of the sum invested.
Accounting for different concepts of value is not without cost. A second activity involves mobilising the resources required - expertise, money, time - to build infrastructure that enables assessment of the organisation's performance in the context of the imagined future activities.
This is likely, as was the case with REDF, to include implementing new systems for routinely collecting and reporting on the appropriate data and hiring employees with experience of tracking that data.
Finally, there is reconfiguring, where the 'conventional' accounting method is reinvented, allowing the data to be processed in a way that reflects the value of the business in a stakeholder-friendly manner.
In REDF's case this led to the Social Return on Investment formula designed to represent the economic and social value produced by the enterprise. In basic terms, REDF used the aggregate net gain resulting from the decreased burden on the state and increased taxes paid as a result of hiring homeless underemployed individuals, coupled with a proprietary risk component - Employment Risk Assessment.
To those embarking on the innovation of new accounting methodologies two cautionary notes are required. First, measuring is not a neutral process. Like in quantum physics, the act of observation can actually disturb the system being observed. Engaging in these activities may well prompt a challenging reassessment of the value that the proposed accounting system is capable of revealing and, furthermore, a critical appraisal of the enterprise itself.
Second, entrepreneurs and executives must be prepared to re-examine the nature of their enterprise. Take, for example a situation where a not-for profit wants to raise funds in the markets. One solution is to issue social impact bonds. However, in order to issue bonds the organisation must agree a measure of social impact contingent on which payments can be made to bondholders.
As a result some employees make it clear that they are philosophically hostile to devoting valuable resources to measuring social impact performance. Some even leave. Introducing the demands of an information system to try and demonstrate value has created a problem in terms of the identity of the organisation.
At the same time designing new systems to account for different types of value can play a powerful role in future success. While accounting tends to be thought of as backwards looking, describing objectively what has happened, it also portrays a plan for action. Yes it describes past performance, but in a highly selective way. As such it provides a valuable tool for iteratively shaping a particular narrative of an enterprise. Not in the sense of fabricating a story, but instead dynamically selecting and surfacing details that create a compelling case for the venture and bring about the desired reaction in targeted stakeholder audiences.
Historically, financial reports have been primarily prepared for and geared towards investors. Fifty years ago attitudes to corporate responsibility and reporting were very different. The gender composition of the board, representation of minorities in the workforce, environmental and social impact, these were way down most corporate agendas, if present at all.
But society has changed. People living next to a factory want to know how much pollution is emitted into the atmosphere. Corporations are expected to act responsibly with respect to the digital assets they possess, such as consumer data.
The greater the call to monitor different dimensions of impact, the more organisations will need to adapt to account for them. Imagining, Mobilising and Reconfiguring, to generate new ways of demonstrating value to stakeholders, is one way they can respond.
Barman, E., Hall, M. and Millo, Y. (2020) "Demonstrating value: how entrepreneurs design new accounting methods to justify innovations", European Accounting Review.
Hall, M. and Millo, Y. (2018) "Choosing an accounting method to explain public policy: social return on investment and UK non-profit sector policy", European Accounting Review.
Follow Yuval Millo on Twitter @yuvalmillo.
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