Social investment is the government’s buzzword, but do you really know what it means? Abigail Rotheroe runs us through the basics

Social investment seems to be the flavour of the month at the moment. There are conferences dedicated to it and numerous reports have been written about it. It has been picked over and analysed from many angles to such a degree that it now seems embarrassing to admit not actually knowing what it is. This article aims to demystify social investment and bring readers up to speed with this exciting form of finance for charities, social enterprises and their supporters.

What is social investment?

Social investment is the provision of finance to charities and other social organisations to generate both social and financial returns. These social returns are more commonly known as social impact. This is the difference an organisation or project makes to the social problem it seeks to solve and the progress made towards achieving a goal – whether it be reducing homelessness, eradicating malaria or improving educational attainment.

Under the right circumstances, social investment can help charities scale up services, develop new projects and smooth out uneven cash flow. The UK social investment market is growing fast – from the creation of Big Society Capital to the proliferation of social impact bonds, including the high-profile example at Peterborough prison.

The UK social investment market is currently worth around £200m, and government has been the biggest source of finance so far. Its vision of a thriving social investment market, in which social ventures can access capital to grow, reflects its policies to open up public service delivery to independent providers.

How is it different?

The double bottom line – social impact and financial return – is a critical part of social investment. It is the aspect that differentiates it from, on the one hand, a grant (which does not look for any financial return) and, on the other hand, a financial investment (which is only looking for a financial return). The main thing to point out here is that an investor will probably have to give up some financial return to make a social return.

Since social investment is providing some financial return, however small, the assumption is that it will be repaid. Over 90 per cent of all social investment to date has been in the form of bank loans by the social banks, which will have interest and repayment terms attached.

It is often the case that repayment terms may be more flexible than commercial loans, interest rates may be lower and the investor or lender may be willing to take more risk, but the principle of repayment still stands.

So, social investment isn’t a no-strings attached source of income. It is not a free lunch. It cannot replace income lost from a grant or a drop in donations. The organisation must have a way of repaying the investment and, therefore, there must be a revenue stream associated with it. 

How does it work?

Social investment can take many different forms, from straightforward bank loans to more complex financial instruments such as Social Impact Bonds (SIBs), which are covered later. The diagram shows the basic relationship between investor and charity

The charity or social enterprise receives capital from investors to deliver goods or services. These produce an income stream, which must be sufficient to cover the costs and to deliver a surplus which can be used to pay back investors.

Who is it for?

Social investment tends to be appropriate for charities when they have been unable to afford, or have been denied access to, commercial loans. Social investors may also be more flexible than commercial lenders, and will place a value on the social benefit that the investment will bring.

It may also be that the organisation needs support to get ready for investment and needs a knowledgeable investor. There are a number of ‘investment readiness’ funds that the government has funded to give advice and expertise to help the organisation get ready for investment.

What can it fund?

 Charities and social enterprises have used social investment to: 

1. Buy assets that will generate income – such as property.

Golden Lane Housing, a subsidiary of Mencap, launched a £10m charity bond in February this year. The money raised will be used to buy high-quality houses and bungalows in residential areas to home people with a learning disability, which will be supported by Mencap.

2. Plug a temporary cash flow shortage – but not to fund ongoing losses.

CAF Venturesome provided a loan to Andrew Lees Trust (ALT) to bridge a gap in their cash flow. ALT had secured a grant from the European Commission (EC), but as this funding is typically paid in arrears, and 10 per cent is retained until project completion, the organisation was left with a gap in their cash flow.

3. Grow capital – to enable organisations to move from small scale to larger scale.

Spring Health has designed a low-cost model to operate a chain of safe water kiosks in India. The company uses a motorcycle-based distribution system to deliver liquid chlorine doses, used to disinfect water, into cement water tanks constructed outside of existing retail shops in rural communities. Social investors have provided investment to scale up the pilot phase

What are the risks?

As investment cannot replace the income that charities receive from donations and contracts and involves significant risk, it is not suitable for all organisations. Failing to make repayments may put the charity under financial pressure or, at worst, could force it to close. So charities need to think carefully before taking on social investment. They need to understand the risks and take steps to mitigate them. They need to be clear about how the investment will create social benefit and improve the lives of their beneficiaries.

That being said, for charities that are confident of a future income stream and have considered the risks fully, social investment can be an effective way to enable them to do more for their beneficiaries.

How do SIBs fit in?

No discussion on social investment can avoid the hot topic of SIBs, which, despite being only 5 per cent of the market, have garnered many column inches. SIBs are one of the most high-profile forms of social investment. Developed by Social Finance, a UK social investment intermediary, they are essentially contracts whereby the public sector commits to paying for improved social outcomes.

Social investors provide the capital to deliver a set of interventions and, if the improved social outcomes are achieved, the public sector pays investors back and provides them with a financial return. If social outcomes do not improve, investors make a loss.

For SIBs to work, improved social outcomes must also create significant savings to the public purse; it is from these savings that investors are theoretically repaid. SIBs have been developed in the fields of prisoner rehabilitation, homelessness, and children in care on that basis. They are complicated instruments with high development costs, but the government is keen that their numbers grow.

So what is holding social investment back? 

With the full backing of the government and lots of publicity, social investment is in on everyone’s radar. Charities are considering whether there is an opportunity to increase their impact with social investment – but they need support to do this. Many do not have revenue streams that can be used to repay investment. Funders are keen to get involved, but while they are experts in assessing charities for grants, they often do not have the skills required to assess the financial aspect of social investments. 

This leaves a skills gap on both sides. However, this is gradually being addressed and, as this happens, the potential for social investment can start to be realised. 

Abigail Rotheroe is a consultant at the charity think tank and consultancy NPC

This article first appeared in The Fundraiser magazine, Issue 36, December 2013