Prioritising Impact: How patient is patient capital?
How can we provide more patient, affordable, risk-tolerant and flexible finance to social enterprises?
The social enterprise sector is contributing £60bn a year to the UK economy and employing up to 2 million people. But could those figures be much higher with access to the right opportunities?
Social Enterprise UK figures show it typically takes 15 years for social enterprises to get to the £500,000 turnover milestone – that’s much longer than for other sectors such as technology or healthcare.
Why so slow?
Dirk Bischof, CEO of London based accelerator network Hatch Enterprise, suggested a big part of this issue was access to markets. But it was also about access to finance, he said. Instead of following the textbook growth path, a typical, small social enterprise faced constant cash flow problems – and it was unclear who would fund the difficult transition from small, grant-funded enterprise, to one ready to take on major contracts, or one with a strong direct-to-consumer business model.
Many of the biggest success stories appear to have benefited from having big backers early on. One example given was apparently losing £25,000 a month in the early days while it developed its revenue model, but it benefited from a £500,000 investment over three years to help get to scale.
“How many passionate entrepreneurs are we losing, because they run out of steam in the process?” asked Bischof.
Some investors are adapting their approach. Seva Phillips, from Nesta, said the organisation’s Arts Impact Fund – which is nearly fully invested – had a minimum threshold of £150,000. That’s quite high for many arts and culture organisations, so last October, Nesta launched the Cultural Impact Development Fund, offering £25,000-£150,000 loans, at interest rates ranging from 5.5% to 8.5%. Those rates can be reduced if the organisation achieves pre-agreed social impact targets; organisations can also renegotiate targets during the course of the loan.
Bridges Fund Management, meanwhile, launched its Evergreen fund in 2016, a response to demand from investees for longer-term, patient capital; it’s the first patient capital vehicle for investment into both mission-led businesses and social sector organisations.
Scott Greenhalgh, who oversees the fund, explained some of the reasons, as follows:
1. Certain mission-led businesses want a partner with a longer time horizon than the typical fund that seeks to invest for 3-6 years;
2. For some organisations, the idea of an ‘exit’ sits uneasily with them and may be something they actively don’t want – for example, businesses that are (or wish to be) majority employee-owned or social sector organisations will not want a partner that needs to sell after a particular investment period;
3. In addition, Bridges feels that organisations that rely on public money for their income and/or those that look after vulnerable people, benefit from not being focused on a sale of the business after a specified period. A long-term focus generally serves the mission of the business better.
Patient capital doesn’t just refer to smaller organisations, though. Large, mature organisations, can also benefit from patient finance – particularly those delivering public service contracts, which may need patient finance because of how the contracts they have are structured (up-front costs may need to be met to set up services but ‘payment by results’ agreements might delay payments until later).
For organisations that are asset-locked, and so unable to take on equity finance, a solution may be to move part of that organisation’s work into a mission-driven business set up especially, and attract investment capital into that from a joint venture funding partner.
Alternatively, as one participant suggested, we should be “getting the best financial brains to look at getting equity investment into asset-locked organisations, rather than requiring asset-locked organisations to turn into something else”.
How do we get better products into the sector? Some ideas from the session are listed below.
More affordable investment could come from:
Innovating - we could do much more with things like quasi-equity, convertible notes...
Linking repayments to profitability, not growth.
Offering repayment holidays.
Doing a big education exercise around Social Investment Tax Relief (SITR): it allows investors to take more risk; its impact could be huge, but most people are unaware.
Doing more to tell a story of social enterprises that moves away from the image as ‘credit-unworthy businesses’. Sell their impact more: the power of that story will attract investors
More risk-tolerant investment could come from:
More investment from retail investors and high net worth individuals, who are often willing to take on more risk.
Thinking at the portfolio-level: accepting that a portion of your portfolio won’t make it – and that’s ok.
Communicating a more realistic idea of likely financial returns in the sector (in terms of comparable risk in mainstream finance).
Partnered funds: using SITR investments and match-funding these with social investment.
More flexible investment could come from:
Ensuring investees are consulted when loans/products are being developed.
Thinking about management structures and types of investment as well, for example loans converting into equities.
A key question about flexibility is where the money actually comes from.
More patient investment could come from:
Recognising that investor motives vary (for example, a family office compared to a pension fund), as well as their liquidity needs. There are opportunities for patient capital in the right places.
Managing expectations among both investors and enterprises: being transparent about what’s a realistic return.
Enabling more blended capital (for example, both UnLtd and Power to Change have offered grants that lead into more commercial money, or are blended with it). Equity is still a problem for asset-locked businesses, though.
Important to note that among investees the need for patience varies; and that many need support, not just cash.