Capital ideas – part two

Investment readiness is often widely understood as a state, which comprises a number of key characteristics, much like business readiness or market readiness. But what it means to be investment ready will vary from one investee to another and is determined to a significant degree by the eye of the beholder – in this case the investor.

As mentioned previously, we’ve recently seen the publication two key reports on the future of the UK’s hype-ridden social investment ‘sector’. The above quote is from the second of these, Investment Readiness in the UKa report from Clearly So and New Philanthropy Capital, commissioned by The Big Lottery Fund.

Investment readiness is currently, in theory at least, the big issue facing UK social investment. Up until the creation of Big Society Capital, the government-backed wholesale finance institution, most of those involved in social investment insisted the key problem was lack of money to support their work. Now that lots of money is available, social investment intermediaries need better excuses for the lack of investment taking place, while the government – which is relying on social investment to somehow plug the gaps created by its record cuts to public services – is getting worried. The drive for investment readiness is the result.

The key question about investment readiness is whether it’s a tautology, a euphemism or both. In the tautology corner, there’s the argument that, as the above quote from Investment Readiness in the UK suggests, the only objective measurement of investment readiness is whether or not someone offers you an investment.

In the euphemism corner, the drive for investment readiness is based on the assumption that most social ventures could reach the point where they would be were ‘ready’ to receive investment if they made a series of changes to the way they operate (probably with the state-funded assistance of social investment intermediary). Clearly there are at least two categories of social venture: (a) those that can get an offer of investment and (b) those that might get an offer of investment if they were better able to demonstrate their business model and the ability of their management team to make effective use of an investment. What the investment readiness agenda euphemistically ignores – while there’s an acceptance that some organisations will continue to rely on grant and donations the implication is that they’re marginal to the debate – are the categories (c) not a commercial business and (d) just commercial enough to survive but not commercial enough to take on and pay back an investment (with interest) from profits.

Despite the clear problems with term, Investment Readiness in the UK makes a significant contribution to the debates around social investment by examining the views of investors, intermediaries and investees and assessing the mismatches between them. It’s particularly interesting because the investee element is based on a relatively large sample, 1255 organisations from what the authors describe as the voluntary, community and social enterprise (VCSE) sector.

The authors identify six key mismatches between the views of investors and intermediaries, and the views of investees (VCSE organisations who want some money). These are summarised below with a couple of my comments in italics:

  1. Does the revenue model the stack up? – unsurprisingly, investees are more likely to think it does
  2. Lack of appropriate financial acumen (amongst investees) – investees are more likely think they have it, investors are more likely to think they don’t
  3. Investor readiness for investing in social returns – so far, most social investors aren’t especially interested in demonstrable social returns other than the fact that they are investing in a VCSE organisation
  4. Lack of diagnostic tools, lack of clear referral process – ‘Investors describe how they are inundated with unsuitable propositions.’ – it’s difficult to see how this could be prevented, surely investors could solve this problem by using their contacts and expertise to identify investments they do want to make and, like publishers, getting enthusiastic interns to read through the slush pile of unsolicited applications for any gems they might have missed
  5. Awareness raising and presentation of information on social investment – There’s plenty of information promoting financial products to VCSE organisations, not much on how to decide which of these products might be best for you. This is a case of market failure, possibly based on the fact that no one has identified a sustainable business model for providing objective information about the suitability of different types of finance. As Alanis Morissette said, it’s like 10,000 spoons when all you need is a knife.
  6. Support for investors to create and broker deals – investors find social investing complicated and time-consuming. There are no specialists to help. If this is the case, what intermediaries are for/doing?

While it’s useful to know that all these mismatches exist, my hunch is that only 1-3 are critically important to the future of VCSE organisations in the UK and the people they exist to serve. A big problem with 1 and 2 – revenue model and financial acumen – is that there’s at least two obvious reasons why these mismatches might be occurring aside from investors just being wrong but where investment readiness support will be useless.

One is that the investee has a passionate commitment to positive social change but doesn’t really know what they’re doing – in which case, it’s difficult to imagine the sort of investment readiness support which would lead to the organisation getting investment with them running it.

Another is that the investee has identified (something at least very close to) the most commercially sustainable model for delivering the kind of products or services that they provide but this still doesn’t make the organisation profitable enough to give the investor confidence that they’ll be able to invest and make a return. Bizarrely, this is currently the situation (quite openly) faced by CDFIs, themselves part of the social investment intermediary community and some of the people responsible for making social investments (using other people’s money). CDFIs’ answer is not that they need some investment readiness training – possibly from themselves – but that they need a subsidy provided by a government loan guarantee scheme. Ben Hughes, boss of umbrella body CDFA, explains: “It is wrong to suggest CDFIs should cover all their costs through charges and fees…

Under mismatch 3, as well as the as-yet-underdeveloped interest amongst investors for specific social returns (which might be help to offset reduced financial returns), there’s the additional mismatch – previously highlighted in The First Billion – between the products VCSE organisations want and the products on offer: “This mismatch is further evidenced by the type of capital demanded by and offered to the sector. Our survey respondents predominantly seek risk capital on sub-commercial terms of between the £10,000 and £100,000 range. However, if what is on offer from investors is larger asset-backed capital on near commercial terms, there is a market failure, captured in the typical exchange between investors and potential investees who accuse each other of “not understanding the social enterprise model” or “not being investment ready.

Investees responses are indicate that, like CDFIs, 49% of the VCSE organisations currently looking for finance are interested in a ‘mixed funding product’. Mixed funding products are usually products that include a grant element along with a repayable loan, such as those provided by Futurebuilders and Adventure Capital Fund. Unfortunately, only 7% of those organisations who managed to get investment received mixed funding products.

As a snapshot of the current state of UK social investment, Investment Readiness in the UK is as good as gets. It shows us an embryonic sector where there’s a growing supply of money and boundless supplies of (hopefully partially justified) optimism but, as the authors’ rightly highlight, key mismatches between supply and demand. The report provides some useful insights into tackling those mismatches that might be alliviated through skills training and information but, understandably based on its remit, leaves the more important wider questions about how we how we meet social needs in an age austerity and smaller government unanswered.

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16 Comments

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16 responses to “Capital ideas – part two

  1. jeffmowatt

    I’ll share the thoughts of Paul Polak from a recent SOCAP presentation.

    “Conventional Development Aid Has Failed
    Corporate Social Responsibility Is Cosmetic
    Charity Doesn’t Bring People Out of Poverty
    Impact Investing Confuses Social Mission and Profit”

    For some time it’s been apparent that this new breed of social finance intermediaries have been attempting to invent themselves a role in the would be social economy and they’re trying very hard not to hear any business case that doesn’t include them.

    What more can we do? We’ve given them a proven business model for community investment published free to use. We’ve offered our research on using this model in conjunction with a CDFI to offset the cost of lending and we’ve offered a business plan with a primary social objective of tackling poverty, from a share of a 2.2 billion market in rural broadband deployment.

    They can’t or won’t find us.

    With none of this activism, a successful implementation has been established in a neighbouring county with the support of local government.

    Why are they still in denial?

    http://economics4humanity.wordpress.com/2012/10/02/diy-rural-broadband/

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  2. Beanbags admin

    “For some time it’s been apparent that this new breed of social finance intermediaries have been attempting to invent themselves a role in the would be social economy and they’re trying very hard not to hear any business case that doesn’t include them.”

    Not sure whether this about a ‘new breed’ or whether it’s the case for intermediaries in a general sense but I think there’s definitely big questions about where ‘intermediaries’ fit into the developing social investment sector.

    I can see the case for genuine specialists – people who specialise in investment in social care or education or back-to-work services, for examples, or specialists in particular financial products – but not really clear about what ‘social’ specialists bring to the table.

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  3. Thanks David. I’ve got mildly obsessed with this little theme recently. Who knew

    I think we are really overcomplicating this whole business, and the resulting confusion is favouring the creation of yet more “innovation middleware” who don’t actually produce anything but claim to be crucial to creating a viable sector because they alone can teach these poor stupid social entrepreneurs how to become “investment-ready”.

    There are two key problems I can see with the “social investment” market:

    1. Social impact is incredibly difficult to prove or measure without investment, particularly on systemic and preventative interventions.
    2. Most social enterprises are operating in non-viable markets.

    These problems mean that social impact investment is incredibly difficult to secure for unfunded innovators, and commercial money isn’t interested. There’s lots of investment around for viable businesses, but a huge number of the things that need doing for society are not commercially viable.

    The last thing we need is a bunch of management consultants and ex-bankers wading into this sector and making a heap of cash from telling social entrepreneurs what to do. It’s pretty clear how to make money: give up social enterprise and go into management consultancy or banking.

    Making a business “investment-ready” isn’t rocket science: just concentrate all your resources on selling something simple and cheap to make to people who have a lot of money to buy it. Anything complicated or expensive to make is either expensive and exclusive (e.g. private healthcare) or needs to be subsidised (e.g. the NHS). Unfortunately, that tends to be where a lot of the hardest social problems are found

    And that’s why we subsidise them.

    Or rather, why we used to subsidise them.

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    • jeffmowatt

      A simple answer to the question of measurement. Rather than “illusory numerical analyses” or trying to put a price on social innovation, to measure and calibrate in human terms.

      Yunus for example refers to a “bottom line” for Grameen Danone as being the number of children removed from poverty. Likewise, our more recent focus on the number of children placed in loving family homes.

      The UK target was reducing poverty by seeding community development funding to create local and social enterprises .

      Prior to the finance intermediaries, there were still those who had the means to benefit by keeping others from the table. They fill the ranks of local government, development and support agencies:

      http://economics4humanity.wordpress.com/2012/09/20/measuring-social-value/

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      • I like this way of doing things Jeff. The problem with measurement is often that it gets overcomplicated because of the need to translate it into something that makes sense in fiscal terms. So we end up trying to put a cost value on a child being placed in a loving home, when in fact we should just be celebrating that and doing more of it. But that relies on there being someone with money to spend on achieving good things like protecting and caring for children.

        Tim Smit said of the Eden Project that the problem with making business cases for social projects is that the wider business case usually stacks up (e.g. regeneration of the local area, wider tourist revenues, job creation, economic boosts), but the actual business plan often doesn’t. There are many things which would have been hugely beneficial overall which don’t happen because the people investing in it wouldn’t see those benefits come back to them in return for their investment. Similarly many commercial projects that make their investors money also create costs for society and the State. (Cigarettes are a good example of this, which is why they are now heavily taxed.)

        So the measurement is one part of it, and mapping the externalities of each proposal is another. It’s very difficult to get to the true costs of things, and the true benefits, if you are looking at the whole social system.

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  4. Beanbags admin

    Hi Andy,

    Thanks for your comment. The points you’re making would more or less be my starting point(s) in terms of the debates around social investment.

    My points of departure are:
    (a) at the optimistic end of things – I always like to listen to people’s ideas and I’m happy to be proved wrong if there’s positive social outcomes as a result

    and (b) at the pragmatic end of things – I don’t think we can rely on the state to fund or subsidise all the social good that needs doing and, if that’s the case, we have to find other resources to support social good.

    One problem with the social investment market so far is that it seems to be more about marketizing the existing, shrinking social pot rather than using market mechanisms to increase the size of the social pot.

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    • I definitely think the goal of the social investment community is to grow the overall capital available for projects of social benefit, which is obviously helpful. What I don’t think is helpful is pretending that it’s a separate sector, because in reality it is just increasing the amount of commercial and philanthropic capital around to invest in projects that the State can apparently no longer afford. This is money that in previous eras would have been distributed through democratically-accountable channels, but is instead now going to be distributed through market economics.

      For me the big problem with the social investment pot is that it is prone to all the biases of both the commercial market on one side and philanthropy on the other. It likes simple ideas whose outcomes can be predicted, preferably in fashionable areas where there’s little risk and lots of good photos at the end. So good luck getting anything to do with, say, mental health funded. It’s strictly funky recycling projects, community food growing and restaurants employing young offenders here please.

      The social investment market also can’t make a good case for prevention, because the people that do the prevention usually can’t benefit financially from their own success. If you are going to build a sustainable business around a social problem, the last thing you want is for it to go away.

      Very often the only customer for large, high-impact, preventative solutions is the State. We seem to be a long way away from a State actually looking strategically at the problems its people are facing and creating systemic interventions to raise quality of life and reduce future human and fiscal costs. I think handing over control of social investment to the market is a very irresponsible thing for the Government to do, and will result in massive holes in our social provision – which the State will ultimately end up paying for anyway.

      Hmm, I really am getting a bit obsessed with this. I think I’ll have a bit of a lie down. 🙂

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      • Beanbags admin

        Andy,

        I think you’re right that handing control over social investment to the market would lead to massive holes in social provision. I’m not sure I agree that the current social investment industry is actually based on doing that.

        In 2011, what Big Society Capital describe as social investment in the UK was worth £160 million. Big Society Capital will be spending up to £600 million to grow the market, (up to) £400 million of which is unclaimed assets, claimed by the government for the purpose (effectively public money) and £200 million of which is being contributed by major banks as post-crash penance. Social investment in the UK is primarily state-funded and primarily state-directed, albeit through an arms length institution.

        The Big Society Capital model of social investment isn’t designed to fund funky recycling projects, community food growing and restaurants employing young offenders – it’s primarily designed to put money into relatively large social enterprises or charities on the basis that these charities and social enterprises will then be sufficiently capitalised to compete against the likes of Serco and A4E for large government contracts.

        You might get some funding for mental health, if the mental health project you’ve got in mind is to spin-out an NHS mental health trust and convert it into a social enterprise.

        Social Impact Bonds, one of the areas Big Society Capital will be going into, are designed to fund preventative work that is ultimately paid for by the state. As yet, I’m unconvinced there’s likely to be many instances where they’re going to deliver good value for many and improved social outcomes, compared to the government paying upfront.

        None of this is growing the social pot, any commercial money coming in is ultimately coming in on the basis of getting some of the state’s money in future.

        I think we do need to look for ways to grow sustainable social organisations that can remove some of the burdens of social provision from the state while using any profits generated for a social purpose.

        Unfortunately, that’s not what the government wants and, in its present form, that’s not what social investment’s for.

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      • jeffmowatt

        For me, the question remains. Why do we face such resistance to efforts
        aimed at seeding a social economy? Notably, when the CIC model became available in 2005, it offered no suggestion on how it might be funded and that remains a problem for those like John Mulkerrin, The expression “no more scraps” comes from a conversation we had about this issue:

        “Despite the millions that have been invested into social enterprise by the previous Government, virtually nothing has been spent on developing CIC infrastructure in five years, be that accurate and detailed information for professionals and business advisers, or research and development to establish the viability of packaged CIC investment products. I get phone calls almost daily from CICs or potential CICs of all shapes and sizes, and the quality of advice they receive is variable to say the least. CICs have flourished in spite of the indifference to doing anything tangible, not because of it.”

        http://cicassoc.ning.com/profiles/blogs/no-more-scraps-growing-up-and

        By this time it was more than apparent that they just hadn’t considered how it might be propagated.

        It would take another 6 years for the law firfm Bates Wells and Braithwaite to come up with the idea of revolving funding, which was the essence of what we introduced here in 2004.and in the original 1996 paper.

        After being stonewalled in the UK, this predatory culture, of passing of another’s work as one’s own without attribution, follows us to Eastern Europe and will eventually take away everything we invested in over the last 8 years.

        http://economics4humanity.wordpress.com/2012/10/02/do-we-need-ethics-in-social-investment/

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  5. jeffmowatt

    Agree with your conclusion entirely David. The creation of a social economy for me is about creating new business for social purpose to reduce the social burden of the state, rather than turning the social functions of state into business.

    An illustration is the case we made about childcare in Eastern Europe

    http://www.managementexchange.com/hack/every-child-deserves-loving-family

    Sharing knowledge and information has been a key part of our strategy and another unexpected impact came this week. It may have something to do with an email I wrote several years ago. It certainly has a lot to do with what was shared online,

    http://economics4humanity.wordpress.com/2012/10/07/the-email-that-changed-capitalism/

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  6. Investment readiness is a way that investors can have confidence that they stand a good chance of getting their money back. It is often a fairly arduous process – but one that leads to much tighter business model, more accurate forecasting and better execution of the plan.

    UK social enterprises are forever being told they’re not investment ready. So are US social enterprises (I am just back from SOCAP where this was certainly the case). In fact, it is heard by almost all start-ups seeking growth capital, be they social enterprises or not. It is a tough process, but it is necessary for any business seeking growth capital and it almost always leads to more efficiently run businesses. If you want investment, deal with it.

    What is clearly an issue in the UK is that most social enterprises are operating on zero or incredibly low margins (with no prospect of significantly growing what profit there is), irregular cash flows and nobody to sell the business by means of an ‘exit’.

    For these businesses, traditional investment models just don’t work. There are lots of smart people developing financial products that might, the social impact bond being the most well-known. We’ll be exploring them all at Good Deals on 28 and 29 November, and providing lots of practical advice for social entrepreneurs trying to make sense of it all. Check it out: http://www.good-dealsuk.com.

    Nice segway, eh?

    Matt

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    • Matt, A podcast fom Socap12 made for some pretty depressing listening, in that I was hearing ideas read back to me, that we’d shared in the public domain over the last 16 years.
      It may well be the case that many social enterprises don’t achieve high margins, since even those operating for profit will be placing social commitment before income generation.
      While we go toe to toe with organised crime over child exploitation, there’s another world of endless conferences in far away places and that’s where there’s a social economy, in talking our walk

      Myh now deceased colleague pointed to the 600 pound gorilla in the corner 3 years agoe:

      “Finally, is it acceptable to build projects with stolen property? What sort of results would that lead to? Can be build an ethical system based upon unethical behavior (such as violations of Intellectual Property Rights)?

      If we invent such a system, is it anything new? Or is it just a twist on the old system?

      One thing that can be collaborated openly is this: a Code of Ethics. But, whose ethics? What org(s) will enforce them, and how? Who decides who gets in, how, and why?”

      He gave his life and I give my time. For example to comply with a request for our social impact. I hope for this, our commitment, be attributed.

      http://economics4humanity.wordpress.com/2012/09/10/social-impact-of-people-centered-economic-development/

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  7. Beanbags admin

    Hi Matt,

    Thanks for your comments. I think you’re entirely right in terms of the general situation for an individual organisation seeking growth capital.

    The problem with “If you want investment, deal with it” in this instance is that a key premise for the creation of Big Society Capital (not one that I necessarily agree with) is that not enough social ventures are seeking growth capital and pumping lots of money into the social investment market will cause more new or existing ones to do so.

    So, now we have (or will have) institutions and intermediaries with lots of money wanting to make social investments. And we have some people who want to make some (more) social good happen and want some money to do it.

    The people wanting to make social good happen have a range of options including:(a) get social investment – based on both social and (relatively high) financial returns – from social investors (b) get investment from somewhere else, possibly cheaper if they’re profitable (c) keep going without investment (d) get a grant (e) give up and go home.

    The people wanting to make social investments have two options: (i) make some social investments (ii) give and go home.

    It’s not our job as people running social ventures to make social investment work.

    Right now, the onus is on the social investment sector to show why (a) is the best option for people running social ventures that are (or could) be commercially viable and scalable. And more widely, to justify the investment of £400million of unclaimed assets in Big Society Capital, it needs to prove the positive social value it’s delivering through its existence.

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  8. Pingback: The UK B Corporation « Economics for Humanity

  9. Some time ago. I recall that Steven Rockman of Merism Capital spoke out in favour of “for profit” social enterprise , referring to the US B-Corps model.
    A recent find in the Guardian on values-led business reminded me of an earlier conversation with B Corps which explains why it can’t be applied in the UK.
    It turns out the Bill Clinton, the recipient of the 1996 paper describing this model, is now an advocate, albeit for the B-Corps brand.

    http://economics4humanity.wordpress.com/2012/10/13/the-uk-b-corporation/

    In more recent times, we’ve seen On Purpose, Deloitee Pioneers and Wavelength come up with similar thinking. Have they done anything?

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  10. Pingback: Many happy returns? | Beanbags and Bullsh!t

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