Drop your fears on investor profiteering – for goodness' sake!
Social investment doesn't always mean a low rate of return and voluntary and community organisations should set aside their traditional concerns over investor motivation – suggests Baker Tilly's Jim Clifford in his analysis of market trends.
In his June 2013 address to the Social Impact Investment Forum, the prime minister, David Cameron, highlighted the importance of the emerging market of social investment in leading the charge on social change.
That view coincides with a political desire to trade and share financial and outcomes risks, ultimately moving some risk away from the state towards investors and delivery organisations, and compensating for that by allowing investors to share in the savings realised by the public sector.
The emergence of new financing tools such as social impact bonds (where there is a ‘loan’ for a social purpose backed typically by a Payment by Results – or PbR – contract) and social investment bonds (where a debt instrument is put in place for a social purpose, typically to fund the purchase of assets), is broadening the range of investment structures and attracting new classes of investor to the market, including private finance and social investment (see below). As these new funding sources emerge, the traditional players, such as philanthropists and grant makers, are starting to join in the new structures.
New sources of funding
Of particular interest is the subset of social impact bonds within the landscape, which is contributing to the development of a three-dimensional typology for social investment bonds and social impact bonds. The emergence of debt, equity and quasi-equity social investment bond structures offers a foundation for further growth in the market.
Emerging structures of debt with rates of return of 4% to 12% tend to have similarities to commercial debt. This may, for example, take the form of a loan to cover fixed asset purchases, with fixed or guaranteed minimum yield to be paid from income generated by the asset and with structured repayments.
Some debt-type funding offers a blend of fixed yield with a performance-related ‘profits’ element. This can be seen in the recently completed adoption social impact bond (‘It’s All About Me’), which offers a fixed yield of 4%, plus a profit share linked to the success of the scheme, taking the total return over a ten year period to around 10%. With the comparison to the general funding markets for debt, and with the relatively high annual costs of fundraising (some 12% according to the Charities Aid Foundation in 2011) this appears to represent good value for money.
Equity and quasi-equity
At present, the majority of social impact bonds have focused on the ‘quasi-equity’ spectrum in which there is an increased risk to capital, with a higher potential yield to compensate, and with a repayment/exit structure as part of the instrument (akin to mezzanine finance). Until the adoption social impact bond, however, there has remained a mismatch – with some yields either not matched to risk or falling at the lower end of the commercially acceptable range.
In theory, if not yet in practice, there is no barrier to a social impact bond offering permanent ‘equity’ with yields fully contingent upon performance and liquidity/investor exit achieved through sale of the instrument itself including, perhaps, through the Social Stock Exchange that David Cameron alluded to in his June 2013 speech. The charity Scope’s issue of debt listed on the Luxembourg Exchange also heralds some interesting directions.
The way forward: emerging structures
The challenge that broader demand to invest sets for the sector is to look beyond some of the early social impact bond structures, in which equity risk is matched with a relatively lower rate of return than would commercially be expected for that risk. The emerging trend, which started with the launch of the adoption bond, sees a wider range of structures that achieve a true ‘shared value’ position: social investment no longer necessarily needs to come with a low rate of return.
Shared value will drive growth
Ultimately, it is in the best interests of all parties in this emerging market that social impact bond-funded projects are seen to deliver returns that are at least acceptable (if not attractive) based on commercial expectations and that the projects deliver on social outcomes targets. This broadening of investor types beyond ‘social’ investors can only serve to increase the level of funding available to voluntary and community sector projects, and therefore increase the social value delivered.
Investors that are now entering the market have enough experience to realise that sometimes an investment just doesn’t work out, but that putting in place the right structures across their portfolio allows a return to be achieved in aggregate. Voluntary and community sector organisations need to move closer to this way of thinking and set aside any concerns around profiteering by investors that might stifle their ability to fund innovative projects that will change society for the better.
Jim Clifford is head of the Valuations team and of the Charity and Education Sector Advisory team at the accountancy firm Baker Tilly. He will be speaking at the E3M Finance For Social Growth seminar in London on 20 November.