Over the last decade central and local government funding for charitable organisations has been cut back as a result of the drive to reduce the deficit, and donations from members of the public are also coming under increasing pressure. The emergence of a social investment industry (where the UK is seen as the global market leader) promises to unlock innovation and growth in the social sector by providing social sector actors with access to the funding that they have been unable to obtain from traditional lenders.

According to Big Society Capital, social investment can be defined as “the provision of finance to generate social and financial returns”. The ‘social returns’ element implies positive outcomes for society, while financial returns entail that investors will be able to obtain their investment back, with a return.

Market Structure

Social impact bonds – which are not bonds, as we will explain in the rest of the article – have been commented on a lot but only represent a very small portion of social investment.  Social investment includes debt, equity and quasi-equity products:

  1. DebtThis usually takes the form of a loan and generally requires a borrower to repay the amount borrowed along with some form of interest, or sometimes an arrangement fee. Some of the main types are: secured loans, standby facilities, overdrafts and unsecured loans
  2. Equity This usually takes the form of shares issued to an investor in exchange for capital and is permanently invested in the organisation. The organisation has no legal obligation to repay the amount invested or to pay interest. Equity investors expect to receive dividends paid out of the organisation’s earnings and/or capital gain on the sale of the organisation or on selling their shares to other investors.
  3. Quasi-equityThis allows an investor to benefit from the future revenues of an organisation through a royalty payment which is a fixed percentage of income. However, the investor may gain nothing if the organisation does not perform. This is similar to a conventional equity investment, but does not require an organisation to issue shares. The share of future revenues that a quasi-equity investor receives is usually linked to income and not profit.

Market Size

As noted by the City of London, whilst there is a significant asset backed lending by mainstream investors into social organisations, the amount of investment offered to generate social returns has been considerably smaller; it was estimated at under £200m in 2012. Of this, the non-‘asset backed’ capital is estimated at less than £50m, and has been almost exclusively provided to social organisations by social investors rather than mainstream lenders. Likely demand for social investment is estimated to increase to nearer £0.75bn this year.

Actors

A range of actors, from high net worth individuals and ethical banks to pension funds, have participated in social investment to date. These include:

  • Social Investors: Actors who seek social as well as financial returns. These include Government, banks, trusts and individuals. Some social investors invest directly in front-line social ventures while others (the majority) choose to make their investments through intermediaries.
  • Social Investment Finance Intermediaries (SIFI’s): This category stands in the social market between supply and demand, deriving funds from social investors and investing them directly in front-line social ventures. It includes organisations that have social investment as their primary activity, but also entities that use social investment within a varied portfolio of activity.
  • Social Sector Organisations: These are the ultimate recipients of investment, which these organisations use to finance their operations and to actually create the social and financial value that defines the social investment market. These can be charities, co-operatives and social enterprises.
  • Support Organisations: These actors support social ventures – helping them grow, improve and scale – by offering services that range from capacity-building to provision of infrastructure.
  • Commissioners: These are actors who are willing to pay for socially valuable services. In general these are government commissioners, although philanthropic foundations and individuals sometimes take this role.
  • Service Recipients: These are the beneficiaries of the services provided and the social value created.

In general, retail opportunities for social investment will grow in line with the sector’s track record, as it is heavily protected by consumer protection regulations. Investor momentum is gaining traction and the EU is looking to include social investment in its Europe 2020 job creation agenda.

Examples of social investment instruments

Social Impact Bonds

Social Impact Bonds are arrangements with the following features:

  • A contract between a commissioner and a legally separate entity (delivery agency)
  • Specific social outcomes which, if achieved by the delivery agency, will activate payments from the commissioner
  • At least one investor that is a third legally separate entity
  • Some (or all) of the financial risk of non-delivery of outcomes sits with the investor.

The first Social Impact Bond was launched in September 2010 by Social Finance UK, to fund a comprehensive re-entry program for short-sentenced prisoners. Over a six-year period it raised £5 million from seventeen investors.

Social Investment Funds

Mainstream investor interest is growing with some having dedicated social investment teams to invest in social investment funds. The number of social investment funds is increasing. Some of these funds are independent while others are affiliated with large banks or development institutions.

Funds might focus on certain sectors, geographies or investment stages. They typically target market returns investing through a mix of grants, subsidised loans and equity investments. More recently, fund-of-funds have been created to provide greater scale and diversity for institutional investors.

Social Venture Funds

These funds invest primarily in social enterprises, characterised by innovative and entrepreneurial driven solutions for social and environmental issues. Social Venture Funds close a financing gap, providing support when it is not possible to acquire traditional sources of capital.

 

Additional resources on social investment: