A chance to restart the social investment conversation

March 31, 2015 at 09:00

Last Friday saw the launch of the Alternative Social Investment Commission’s report. You can read the full report with its conclusions and recommendations here.

As someone who has followed the social investment market’s development closely after the past few years, this report is a welcome breath of fresh air in a debate which appeared to have stagnated.

The report starts, quite rightly, by looking at what social investment actually is. Over the years, there has been a tendency to radically extend the definition of social investment to meaning any money that the sector receives that isn’t a grant or a contract from government and is repayable. But the sector has long been borrowing money from banks, individuals and other charities for centuries. NCVO’s data indicates that the sector already has over £4bn in loans. So if social investment is to be something transformative for the sector, it has to be something different than bog-standard loans.

This is a useful point to make because surely the real social investment innovation will be in creating a financial framework that meets the needs of charities and social enterprises in achieving their goals, rather than merely trying to repackage traditional forms of investment with a ‘social’ twist. Social impact bonds are a good example of the former, despite its failings.

Just too expensive

But for me the real crunch of the report is the financial mechanics of social investment.

The report highlights that at the moment, social investment is generally more expensive than mainstream capital, and is not in sizes that reflect the needs of the sector.

One of the most interesting graphs is that from the Bank of England’s Trends in Lending report from July 2014 which showed the average interest rate for smaller SMEs (defined as those with an annual turnover of less than £1m) receiving loans as between 4-5%. Yet frequently in the report (and in my travels as well) charities are reporting social investors are asking for interest rates of between 9-15%. This is around double the cost of capital for mainstream SMEs.

It is hardly surprising, therefore, that charities are not leaping for social investment. In a Charity Bank survey from September 2013, 46% of all respondents were put off by the cost of capital – that was more than a similar survey of SMEs.

Given that charities have to operate with far more constraints than mainstream businesses, often operating in the midst of market failure and contending with steep falls in government income (which is one of the main purchasers of social outcomes) – how can social investment as it is currently formulated be expected to meet the needs of the sector?

It is bread and butter issues like the cost of capital, that are the biggest challenges facing the sector in accessing social investment.

The report rightly begs the question as to what additional benefit do charities and social enterprises receive in return from paying more for capital from a social investor. A great many social investors provide other forms of assistance that can be useful. But are they worth that much more? Moreover, in the long term, I doubt that any additional benefits that can be given by social investors can make up for this increased cost of capital. After all, particularly in public services, charities are in a competitive market place. Price is a central factor, and the cost of capital has a big impact on the price of sector services.

Taking a big picture view on financial capacity building 

The report also shows that there is a need for capacity building support, but that this support has often been linked to securing investment or contracts. In the current environment, with contracts becoming harder to come by and with investment not in a form that charities can repay over time, this is a mistake. What we need is financial capacity building that is focused on helping as many charities as possible to understand their business plans and identify how they are going to meet their objectives over the long term. Linking it directly to contracts and investment narrows the pool of organisations that can access it, and encourages social investment to be seen as something separate from the general financial challenges facing charities.

I frequently hear from charities that they need more ‘head space’ to plan for the future and identify steps they need to take to improve their financial performance. Ironically, by shifting away from ‘investment-driven’ capacity building towards a sector-wide drive to improve the sector’s financial capabilities (without strings attached) the government is more likely to improve demand for social investment, as more organisations get their heads around their work.

Can we move on, please? 

What the Alternative Social Investment Commission has done is given us a chance to restart the conversation on social investment. Far too much time has been focused on the pros and cons of social investment as a thing in itself, and on explaining the concept to charities and social enterprises.

My experience is that charities get what social investment is, they just don’t think it works for them. By asking hard hitting questions about the nature of social investment, the issue of subsidy, the cost of capital and the form that capital takes, the Commission is an important opportunity to move the conversation towards brass tacks.

As a sector, we need to start thinking about the nuts and bolts of social investment – conversations that have traditionally taken place without much engagement from charities and social enterprises themselves.

How can we deliver capacity building that works for charities, so that more organisations can plan for the future (potentially with social investment)? How can we reduce the cost of capital? How can we make sure that blended capital works for charities and doesn’t subsidise returns for investors? What role do Big Society Capital and government have to play in the future development of the market?

The Alternative Social Investment Commission has robustly laid out the challenges we face, it is up to charities to now come together and work out some solutions.