Last week saw the welcome publication of some important research from the consultancy Shift Design into the needs of charities and social enterprises for more patient and risk-bearing capital.
I have written before on this topic, highlighting some of the challenges of providing this sort of finance for the sector, but also why this is such an important gap that needs to be filled. Equity investment fuels growth in the private sector but is not possible for asset-locked organisations. For those at an early stage of trading, having to make loan repayments in the short term can be unaffordable.
The opportunity to develop financing tools that recognise the longer-term timescale and variability of some of the sector’s business models, and which link the scale of return to an investor to the degree of success, is huge. And, as the Shift Design report recognises, this is all the more true now as the sector looks to the recovery and seeks to rebuild its trading and asset bases.
The report makes a strong argument that there is more need for this sort of finance than there is demand for it. This is because even though organisations might have business models that require long-term, patient finance, they are not aware that this sort of finance is available, they don’t understand how it works or they don’t know how to access it.
Most research about the financing needs of charities and social enterprises is based on asking organisations what sort of finance they want. Shift Design argues that, for the reasons outlined above, such an approach will underplay the need for patient and risk-bearing capital. Instead, it gathered information about the business models of 321 social-purpose organisations to assess their suitability for it, then asked about their awareness of that sort of finance.
From this sample Shift determined that 18 per cent of social-purpose organisations require patient, risk-bearing capital, compared with about 5 per cent that say they want it. Those 18 per cent might have a need for more capital than those that are suitable for other sorts of finance, such as simple loans. The average demand for finance across those suitable for patient, risk-bearing finance was found to be more than £550,000, 20 per cent higher than those not suitable for it.
If we accept that solving this problem is more urgent than ever, how do we make it happen?
The main conclusion of the report is that further work is needed to build the case for more patient and risk-bearing capital, and to identify the right products and ecosystem of support to sit around them. Developing the right products can be technically difficult, as this report on the topic by the research organisation Flip Finance highlights. However, these are complexities that can be overcome with honest conversations and good legal drafting.
The biggest challenge here is where the money comes from for such financing tools.
The Shift Design report gives the impression that the challenge for investors in providing this sort of finance is one of patience. In making their money available over a longer term, the investor will need to wait longer to get their return. By backing early-stage high-impact business models they will also need to be prepared to receive less of a financial return than they could from elsewhere.
But it’s not that simple. The longer an investor has to wait for capital to be repaid to support this sort of enterprising activity, the greater the chance that it won’t be. The risk from an investor perspective is not the time horizon itself (plenty of social investors can operate on a long time horizon), but that the returns will not be enough to repay their capital, let alone make any positive return.
One telling finding from the Shift Design research is that, of the organisations suitable for risk finance, those with longer trading histories were less confident in their ability to repay.
In the private sector this risk is managed because one or two investments will go on to see spectacular success, more than paying for the majority that don’t. But in our sector it is morally problematic to extract so much value from a successful social enterprise model even if it is a commercial success.
This suggests that the capital investors make available in this way will require some form of subsidy in a blended model. Access has recently received £30m from dormant bank accounts, part of which will provide this sort of subsidy in financing models to support the sector in the recovery. We hope that in doing this we will be able to further build the evidence base for the need for this sort of finance, and not just the demand.
Seb Elsworth is chief executive of Access, a foundation that helps to widen access to social investment for charities and social eterprises