B minus. Could do better. A fairly standard appraisal in the social enterprise sector of the kinds of repayable finance – loans and equity investments – out there for them. The arguments behind this have been made many times before, but for those new to the discussion, I’ll restate the key points here:

• Social enterprises take longer than regular SMEs to reach comparable levels of turnover; scale can be tricky, which necessitates a longer-term, more patient investment approach. (See Social Enterprise UK's 2017 State of Social Enterprise Survey for the data)
• Social enterprises typically have few assets – so there’s little in the way of collateral that can be offered for longer-term, secured money like mortgages.
• Most social enterprises do not operate in markets where it’s possible (or desirable) to generate huge profits that can meet high return expectations of more commercially inclined investors.

From a traditional investment perspective, attempting to solve for all of these needs is a bit like squaring the circle. The sector’s basically asking investors to take more risk, expect less return, do it over the longer term and with little or no security. But given that social impact investors are an innovative bunch - or at least seem to be interested in creative solutions to complex problems - this should be a welcome challenge.

Meeting the challenge

Earlier this year I attended The Gathering – essentially Burning Man for the UK social investment community – where I co-hosted a session with Dirk Bischof from Hatch Enterprise and Scott Greenhalgh from Bridges Evergreen Holdings to meet that challenge head on. While Dirk threw down the gauntlet from the entrepreneurs’ perspective, Scott and I provided a couple of examples of what’s being done already to address these capital issues.

Bridges’ Evergreen fund provides long-term (10+ year) risk finance of £2 million - £10 million, in the form of either debt or equity and without the need for security – or an exit. The fund is looking to recoup its investments by means of dividends and interest payments and, as such, looks for opportunities in proven business models with strong growth projections. Bridges’ successful track record in the UK social investment market has helped it to get this structure off the ground and persuade its own investors.

Meanwhile, at Nesta Arts and Culture Finance, the Cultural Impact Development Fund takes the idea of trading off financial returns in favour of social returns quite literally. Borrowers have the opportunity to reduce the interest rate payable on their debt if they can provide evidence for agreed annual social impact targets. The fund offers unsecured loans of between £25,000 - £150,000 and is supported by Access – The Foundation for Social Investment, with capital from the National Lottery Community Fund and Big Society Capital. Over a five-year repayment period, a maximum discount of 1.8 per cent is possible – a fairly significant haircut to an average interest rate of 7 per cent.

New ideas?

Following these examples, we asked the audience, comprised of other investment intermediaries, investors, advisors and entrepreneurs, in an attempt to elicit ideas about how we might make finance more long-term, risk-tolerant, affordable and flexible in nature.

This was a far-ranging conversation involving around 30 people – and I don’t have nearly enough space here to do it justice! But here are the main takeaways for me:

• Affordability is an education issue for both investor and investee: investors all too often don’t appreciate how prospective borrowers perceive affordability, and borrowers themselves seldom understand the capital supply chains and fund economics that determine pricing.
• Social investors are actually quite a flexible bunch – often willing to make variations to deals when things don’t go according to plan. There have also been many experiments with more flexible products – revolving credit facilities (e.g. Northstar Ventures), convertible loan notes (e.g. Young Foundation) and revenue participation agreements (e.g. CAF Venturesome).
• It feels like there is a big opportunity for retail investment – making social investors of people like you and me – through, for instance, ethical investment platforms, particularly for discrete, community-focused projects. Whilst there are obvious regulatory issues to be resolved if organisations are to crowdfund loans from the general public, it often feels like there’s a growing tide of appetite for a more socially conscious financial system – which could be a source of more liquid, long-term money. Platforms such as Ethex are leading the way here.

Phillips’s reflections

Having had time to reflect since The Gathering, three other ideas come to mind that would help us create more useful investment products for the social sector:

1. This isn’t new, but it mustn’t be understated: there’s a much bigger role for public and philanthropic money to play in the social investment market. From programme-related investments, to leveraging more risk-averse money using repayable grants, to simply bringing expertise within a sector. For example, Arts Council England has brought invaluable expertise around business models, artistic excellence and a pipeline of deals to the Arts Impact Fund.
2. Investors and their intermediaries need to set more realistic returns expectations. They need to recognise right from the start that achieving outcomes at all, let alone sustainable and replicable positive impact is both difficult and expensive. Whilst it is hopeful that we may transition to an economy where social good is properly valued and there are more profitable, trading-orientated social enterprises, there simply aren’t too many now. But there are plenty that do good and make more modest returns – and this should be our sweet spot. This is basically the community development financial institutions (CDFI) market in the USA; it works and it is growing.
3. Staying with US for inspiration, CDFIs have recently begun making multi-million dollar bond issuances on public markets– a source of cheap, long-term cash that can be passed on to front-line social enterprises. This has been possible through US Treasury-backed bond guarantee programmes for CDFIs, extensive track-records in the social lending space and good data on what investments work. I think we’re on the cusp of that in the UK – the Threadneedle UK Social Bond Fund being an example of a large-scale capital raise with a social impact. It would be good to see more social investment intermediaries pooling resources to work out the feasibility of similar structures.