Capital ideas – part one

For the first time, this report provides us with a clear and logical approach to understanding the drivers of social investment demand.

So says Nick O’Donohue, chief executive of Big Society Capital, in his introduction to The First Billion: A Forecast of Social Investment Demand, a report from Boston Consulting Group commissioned by his new wholesale finance institution. He’s completely right, although given that the government has long since taken decision to give Big Society Capital £600million from unclaimed assets, it’s somewhat perplexing that the issue of demand hasn’t merited logical analysis at an earlier stage.

The First Billion is one of two recent reports – the other, the Big Lottery-commissioned Investment Readiness in the UK will be covered in part 2 of this post – which are on the one hand both timely and useful, but serve to illuminate the hype-drenched confusion and bluster that characterises the embryonic UK social investment ‘sector’.

The First Billion takes its name from the authors’ estimate that demand for social investment could rise from £165million in 2011 to ‘as much as £1billion by 2016‘. This is based on: “a series of favourable trends: Growing outsourcing of public services to private and social providers; a new statutory requirement for commissioners to consider social value when awarding contracts; and a shift towards higher-risk models of payment, such as payment by results, that will encourage social organisations to favour social investment over the commercial variety.

So far, so possible quote from optimistic sector leader who doesn’t know much about finance, but fortunately it gets more interesting after that. The authors’ note that: “The challenge, however, will be translating this potential demand into actual demand, and then from there into real social investment deals.”

They make some suggestions about the actions needed to meet that challenge:

These include:
• A greater willingness by investors to accept higher levels of risk from social investments
• Increased specialisation of intermediaries in economic sectors, such as in community enterprises or in health, or in functional areas, such as brokerage or impact measurement
• New forms of “value sponsorship” to replace block grants, i.e. increased purchasing of goods and services from social organisations by government commissioners, foundations, philanthropists, conscious consumers and sociallyminded businesses

The most shocking thing about this report is that the authors’ apparently embrace the radical idea that social investors and intermediaries actually need to explain what it is that they have to offer to their customers but that conventional finance providers don’t. They rightly point out that: “Any organisation that is able to credibly promise to repay its investors with an appropriate level of interest should be able to access funding from the commercial capital markets (including high street banks). Since social investment, by definition, targets financial, as well as social returns, it is not immediately apparent why social organisations with viable business models should seek finance from social, rather than commercial, investors.

It’s never been apparent to me and I’ve never heard an explanation from the many (often publicly-funded) social finance intermediaries turning up at social enterprise events. They generally just offer tedious variations on: ‘You’re too thick to write a business plan, your suits are clearly off-the-peg and did I mention I used to work in the private sector where they do real business?’

At which point you can approach them to find out more about their exciting offer of cash at an above market rate of interest, secured against a building, following 18 months of due diligence processes.

Fortunately, the report reveals that there is an ‘offer’ from social investment after all and, in theory, it’s this: “There are, nevertheless, three compelling reasons for social organisations to use social investment: Social investors have a superior understanding of social business models; they are able to take risks on innovations with primarily social, rather than financial, returns; and they are more willing to entertain trade-offs between social and financial goals than their commercial counterparts.

Unfortunately, while there are honourable exceptions, the social investment sector as whole doesn’t actually offer these things – expertise, riskier money, and (financially) cheaper money – and it’s not even clear than most investors and intermediaries have even got to the point of aspiring to do so.

A problem with the first ‘reason’ for social investment is that, while it might useful to meet an investor, or work with an investment intermediary, who understands what you do, what you do is probably not specifically ‘social business’. Your organisation is more likely to be pursuing a social business approach to delivering mental health services, or managing property, or getting people back into work. For many organisations at the point of taking on significant investment, it may not be obvious what a generalist ‘social business’ expert has to offer that a generalist business expert doesn’t – aside from the fact that, perhaps, the government is paying for them to turn up, which is not necessarily a guarantee of quality.

As the authors note: “Currently, the immature state of the social investment market means that most social finance intermediaries have chosen to specialise in social investment as a sector. ‘Social’, however, is no longer an adequate specialism. Intermediaries will need to develop strong specialist knowledge and expertise in specific economic sectors if they are going to continue adding significant value in the market, beyond the administration of investor funds and the collection of interest payments.

The failure to offer risk finance has been a particularly embarrassing one for social investors so far. As the report authors point out following their analysis of demand across different sectors of social activity: “One common feature across all these sectors is the type of financial product demanded by organisations seeking social investment. When social organisations can offer high quality collateral as security on debt, they are likely to source that debt from commercial banks or other commercial capital providers.

This means that: “the demand for social investment will be focused on a set of higher-risk financial products, such as unsecured lending or quasi-equity, where returns are linked to the financial success of the organisation.

Unfortunately, as reported previously: “Lighting the Touchpaper found that 84% of social investment in 2011 was secured lending, dominated by social banks whose responsibility to depositors forces them to take low risk positions. This compares with an estimate for the nature of demand in 2015 that suggests an entirely upside-down need for primarily unsecured forms of finance.

Basically, many social investors are competing directly with commercial banks in a market where they lack the financial clout to compete and have nothing distinctive to offer to potential customers – in many cases owing their continued existence to huge grant subsidies (based on 2011 figures, intermediaries have an average 55% gap between earned income and operating costs). This may raise questions about whether they’re the ideal people to be lecturing social organisations on the need to develop sustainable business models.

That said both ‘risk’ and the final’reason’ present as bigger challenge to Big Society Capital itself as they do to the other investors they’ll be investing with and the intermediaries they’ll be investing through. There are some investment intermediaries who, as yet, have been denied the chance to test their expertise due to the fact that they’ve been administering (often goverment-backed) funds with more strings attached than a millipede in a puppet theatre. If the social investment sector can’t put money into things that might generate significant social change but also might fail, its existence seems fairly pointless.

Realistically, this means that Big Society Capital will need to support investments that are riskier enough for it to lose some money overall – not least because successful social ventures won’t make the level of profit necessary to make up for the losses. This crosses over with final ‘reason’ for social investment. Clearly, social investment will be more attractive to social organisations if investors ‘are more willing to entertain trade-offs between social and financial goals’ and provide money at a lower cost.

Unfortunately, the idea of taking a reduced financial return based on proven social outcomes doesn’t really tally with Nick O’Donohoe’s position that his organisation is not interested in ‘soft loans’. It seems likely that Big Society Capital may need to develop a nuanced interpretation of the term ‘soft’ if it’s going to succeed in both stimulating and meeting the demand for £1Billion in social investment by 2016.

Part two of this post – on Investment Readiness in the UK – will follow later this week.



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8 responses to “Capital ideas – part one

  1. jeffmowatt

    Writing reports and projections is all very well David, but what has become glaringly obvious is the unwillingness of social investment expertise to connect with those is purports to be focussing on.

    Their assertions that we’re not investment ready and have no ability to produce a business plan, simply don’t hold water, when one examines the evidence online. The inadequacy of the current economic system to address social objectives, the reasoning for shifting from shareholder primacy toward a social focus and detailed business plans are all there, long before they came on board. It is they, it seems, who are without a business plan or the ability to create.

    Three years ago, those who’d become practically involved, were asked questions about the gap between impact ideas and the organisations available to fund them. The responses offered some home truths about the authenticity of social investors.

    In 2004, our search for investment at a market rate of interest trawled though ICOF and other social lenders. We approached the regional development authority and many support organisations, finally tackling Baroness Thornton Chair of the SEC about the inadequacy of social finance.

    We drew attention toe the need to tackle poverty, not only as a moral, but also a strategic imperative. Capitalism demonstrated its insufficiency 5 years later, followed by the anticipated uprisings just a year ago..


  2. jeffmowatt

    In just the last few days, there’s been some interesting developments. First Vince Cable in speaking up for CDFIs, which as I’ve described earlier were our proposed vehicle for funding a social economy.

    Going back to work in Eastern Europe, the case was made for social business, described as a Community Funding Enterprise, offsetting the cost of lending in partnership with a CDFI.

    Then there’s that stuff about changing capitalism. Three years ago, I appealed to Sir Richard Branson’s Virgin Unite for support in Ukraine. Now he’s going to make a better capitalism.


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