Eastside Primetimers Richard Litchfield has written for Pioneers Post about the UK social investment market and the role of Big Society Capital, generating significant debate in the sector. The article has since prompted a response from Big Society Capital chief executive Cliff Prior in Pioneers Post, as well as commentary from Access Foundation chief executive Seb Ellworth and Social Spider managing director David Floyd.
In spite of all the hype around social investment, only a tiny proportion of the UK’s social enterprises and charities have made use of it. If things are going to change, Big Society Capital must rethink its role, says Eastside Primetimers’ Richard Litchfield
Although there’s much praise of social investment in the UK, in reality it isn’t actually a very significant funder. Despite its enormous potential, this type of finance remains comparatively underutilised by the charities and social enterprises it was intended for.
By way of comparison, the third sector took up around £730m of social investment in the year ending 2017, but £22bn in grants and donations during the same period.
Moreover, Big Society Capital estimates that 1,100 charities and social enterprises accessed social investment in 2017. This is an impressive increase from the early days, though this represents a take-up by less than 1% of third sector organisations annually and a much smaller percentage still by the broader social sector (which the NCVO almanac estimates at over 400,000 organisations).
So why is this? Charities and social enterprises regularly make two complaints to us at Eastside Primetimers: first, about the price of the finance and second, the length of the investment process (from enquiry to getting the money). They have good points about both, but I’m going to focus here on price as it’s the biggest lever to increase the attractiveness of social investment to a wider market.
The problem is that healthier organisations will find social investment rates uncompetitive (housing associations and leisure trusts are good examples and are able to borrow more cheaply on capital markets or from banks); while those who cannot access mainstream finance will struggle with affordability and may not be able to meet payments which are usually between 8 and 10%.
I’m convinced that price is a bigger deterrent than is commonly accepted
For over a decade, Eastside Primetimers has been helping charities to raise finance and, like others, I’ve developed a well-honed patter to justify the cost of capital and benefits of social finance (of which there are many). However, I’m convinced now that price is a much bigger deterrent than is commonly accepted. It’s very hard to say how many organisations are put off by the cost, but we find that the rates surprise nearly all our clients. How many more charities would take on social finance if the rates were lower?
High interest rates create other unintended consequences. We commonly find that organisations will make an informal loan enquiry, and then go back to the drawing board, search for grants and alternative financing alternatives, before, as a last resort, returning to social investment. This additional time is potentially catastrophic – projects are delayed or cancelled – and it embeds inertia into charity management. Some organisations, after delaying too long, then start raising finance from a position of weakness rather than strength.
So why is the cost of social investment so high to investees, and can anything be done about it?
A quick look at the business model of social investors explains how they need to charge sufficient interest to repay the interest on their capital as well as covering their own overhead costs and any loan defaults or deferments.
Big Society Capital is the largest provider of capital to charities and social enterprises in the UK and, in its role as social investment wholesaler, usually distributes funds to social investors at the top end of 4 to 5%. Consequently, each social investor needs to add a similar mark-up to cover their own overheads, resulting in a charge for borrowers of about 8 to 10%. Whatever the changes in base interest rates, there is not much wriggle room for social investors, many of which are running very lean operations.
|Big Society Capital: Quick facts
Social investment portfolio
From BSC 2018 Financial Statements
So should BSC be charging 4 to 5%? I think now is the time to challenge this. I’m not convinced that the sector is stable enough and the financial products attractive enough to justify both the wholesaler (Big Society Capital) and retailers (social investors) making commercial returns. And why should the wholesaler be aiming to make a commercial return, given that it was founded with a windfall of dormant assets intended for the good of the social sector?
Perhaps, then, it’s a practical requirement because Big Society Capital needs to generate sufficient income to cover its own overheads. In Big Society Capital’s 2018 annual report, it reported an income of £6m from lending to social investors (excluding a write-down of the portfolio) and used this to cover the salary costs of its 60 staff.
We estimate that this income is set to increase in future years in excess of £10m as its funds under management become fully invested (this analysis excludes the effect of the changing value of the portfolio from year to year). The size of Big Society Capital’s staff team far outweighs the size of any frontline social investment fund, raising the concern of mission drift. Does it base its staffing requirements on operational needs, or has the growing financial envelope encouraged the organisation to raise the horizons of its imagination? (Which is, of course, fine if it can be justified.)
Many people at Big Society Capital and other commentators, like myself, argue that blended finance is the answer – providing a blend of subsidies and loans to make finance cheaper and/or more patient. Ironically, though, so long as Big Society Capital is funding the market at 4 to 5%, then there is limited scope for this. As an example, the Access Foundation has been working hard to structure its Growth Fund investments as blended products for smaller organisations. And yet the average interest rate it achieves on these investments is 7.3%, according to the Access Quarterly Dashboard for the first quarter of 2019, which is not much different from the norm for other types of social investment.
|Are the goal posts moving?
Big Society Capital’s five strategic goals are to support and invest in innovative models that use social investment to:
To be clear, I don’t have a problem with the fairness of rates. There are good arguments about current terms reflecting the risk of investments. Social investment is certainly not exorbitant.
My point is a pragmatic one, because, despite an increase in loans in recent years, social investment is making only small inroads. The frustration is, frankly, that we haven’t got further in the eight years that Big Society Capital has been shepherding new capital into the sector.
Big Society Capital could choose to scale right down and simply act as an accountable body holding capital which is passed on with a small admin charge
There are different possible solutions. Most radically, Big Society Capital could choose to scale right down and simply act as an accountable body holding capital which is passed on with a small admin charge to capitalise social investment firms. Alternatively, it could focus on its original mission as a wholesaler. This would require a smaller team than today and the organisation could, say, halve its expected returns and ask social investors to pass on the savings to their investees. Would this turbo-charge the attractiveness and take-up of social finance? I think it might.
As Big Society Capital has an effective monopoly on the supply of social investment capital in the UK, it can make decisions that have a system-wide impact. At the moment, it is, unfortunately, part of the problem, not the solution – and almost every social investor I speak with will say this privately.
We must open up the debate about what capital is needed and how it can be supplied more cheaply. Without a fundamental change in approach, I fear that Big Society Capital will fail to live up to its mission of transforming social investment.