Utilising the capital resource of social finance
Why is it that charities are becoming increasingly interested in social finance, enterprise and investment? The answer is that the prospect of alternative funding which can lead to meaningful outcomes in terms of the charity's purposes is an attractive one.
The charity sector is indisputably under pressure. Governmental budget cuts have begun to bite and experts seem to suggest that this will only get worse. Many charities have allowed public sector revenues to increase as a percentage of their income over the past decade or so and with this source in decline, the charitable sector is being squeezed.
Falls in interest rates to previously unfathomably low levels have reduced the income which foundations and endowments receive. While some have dipped into corpus in order to ease the short term pain of the sector, this is not a sustainable solution.
Similarly, charities had reserves, or undervalued assets such as buildings, and these have been used creatively to make up some of the shortfall, but this too is not unlimited. Finally, business plans based upon life "as things were" are simply not viable. As a result, the search is on for other means to finance work that can achieve charitable objects.
Capital available for deployment
What many charity CEOs have noticed is that there is a great buzz around social investment. What others have noted is that the pool of capital available for deployment, though small, seems to be growing at nearly 40% per annum. This is being underpinned by some widespread changes as well as some governmental programmes - all of which are being usefully crystallised by Big Society Capital, which is independent of government, but was created by it.
BSC will come to have over £600m of funds, mostly coming from unclaimed assets in financial institutions (few are shedding tears for the banks as they are losing these) to utilise in building a large and vibrant social investment market in the UK. As its funds are being matched at least equally by other funds, this represents a £1bn+ pot of funds that are available for social investment. In fact, it appears to be catalysing far more than this.
While insufficient to solve all the problems of the fiscal crisis for charities, this is an undeniably large pool of capital, growing fast, and has the potential to be deployed against projects which generate social impact and are consistent with, in certain instances, charitable objects.
Charities already own entrepreneurial endeavours - in fact many have already established trading subsidiaries, with the aim of generating income for use elsewhere in the charity. What is unique about social enterprises is that they can generate income, but at the same time, are achieving charitable objects.
Think of The Big Issue (one of the UK’s better known social enterprises), a self-sustaining organisation. The social enterprise creates a double benefit for the charity in that it generates income (all post-investment profits are passed to The Big Issue Foundation) and, by virtue of what the social enterprise does, it is also generating social impact.
In the case of the Big Issue there are several benefits: helping the homeless back into work; developing commercial skills for the individual vendor; helping the vendor generate an income in a fashion that is considered preferable to begging.
This is the beauty of social enterprise - it addresses many problems simultaneously, and should do so in a fashion that is cash-generative, like the trading subsidiary of the charity. Like the trading subsidiary, things may or may not work out financially, but unlike the trading subsidiary, even if they operate at a loss there is social benefit. With a trading subsidiary, it is generally only the profit that is sought, and if this does not result there are generally no social benefits.
Running a social enterprise contains similar challenges to running any business. A strong management team, financial controls, routes to market, a competent and well functioning board, and much more are necessary ingredients in any successful enterprise. Social entrepreneurs, like the executives of any organisation cannot and must not rely on their social mission to excuse sloppy practices or incompetence.
Evidencing positive social impact
What is unique is that social enterprises have certain obligations which normal businesses do not have - namely to generate, measure and evidence positive social impact. This is important to all stakeholders and might be mandatory to some of the socially-minded investors who are emerging to back such enterprises.
They do, on the other hand, possess important advantages, such as the ability to sell products at higher prices because of their ethical orientation (think of Fairtrade), the ability to secure volunteers and increasingly access to attractive sources of capital, sometimes at substantially superior rates to mainstream sources. It is for this reason that charity CEOs are increasingly interested in the sector.
However, social investment is not an alternative to grants. Social investment is only useful to charities when they themselves need to make an investment. This could be a capital investment, or an investment in technology, or even an investment in a new team of people - but such an investment must enable the charity, ultimately, to generate incremental income.
It is frequently the case that charities lack the capital resources to engage in long term projects that ultimately benefit their clients. Social investment is therefore a great tool which enables such investment and can unlock massive opportunities to generate income, even surpluses as well as to create more social impact - but it is most definitely not an alternative to donations or grants.
Investor perception of project risks
Social investors want their money back. In many cases, they also seek a return—and in some instances they look to make an attractive rate of return. This is one that at least compensates them in some way for the risk of non-repayment.
It is important for charities which are interested in securing social investment to understand how investors are likely to perceive the project risks. What might sound an extraordinarily high interest rate or expected return to investors just reflects this uncertainty. Frequently there are actions charities can take to mitigate such risks and which will reduce the cost of capital - but sometimes this is not possible.
There are investors who are willing to accept a rate of return that is below the rate that would be suggested by the inherent riskiness of the project. Their number is growing, but they are still somewhat rare. What is nearly non-existent is a group of investors who are not bothered about a return of capital.
Charities should understand that investors, unlike donors, expect at the very least to see their capital returned. If this is unlikely with respect to the projects at hand that charities would be better off not searching for social investment - but for those which are opportunity-rich and capital starved, social investment can be an extremely useful tool.
