Risk finance: potential future uses within the UK social investment market

In the third of his Risk Finance guest blog series, David Floyd considers the potential future uses of risk finance in UK social investment

In the first two blogs in this series I introduced our previous work on risk finance before looking at the use of alternative investment models in social/impact investment around the world.

In this blog, I consider the potential future uses of risk finance in UK social investment based on the emerging themes from our current research and recent developments within the UK market.

What we know so far

When social investment wholesaler Big Society Capital (BSC) launched in 2012, social investment leaders expected a significant expansion in demand for social investment from charities and social enterprises.

The BSC-commissioned report from Boston Consulting Group, The First Billion, predicted the value of investment in 2016 would be five times as much as it had been in 2011-12 based primarily on increased demand for near-commercial loan finance to support delivery of public sector contracts. 

The clearest evidence of actual demand from charities and social enterprises seeking investment at that time – as shown by research based on responses from over 1000 charities and social enterprises – was for different kinds of finance to what was on offer from the mainstream market. The Big Lottery-commissioned, Investment Readiness In the UK, reported that 49% of organisations seeking finance were looking for a ‘mixed-funding product’ – a combination of grant and loan finance – while only 7% had managed to secure it.

A further illustration of the irrelevance of conventional loan finance to many organisations was provided in a 2014 report from Seebohm Hill. This research, based on an analysis of social enterprises in the North West, concluded that based on their size and profitability ‘loan funding is not a suitable way of financing the majority of social enterprises’.

While the extraordinary rates of growth in UK social investment predicted by The First Billion did not happen, the market grew significantly between 2012 and 2016 however, while data is incomplete and definitions are disputed, my assessment of the broad picture is that there was not an increase in risk finance deals during this period.

Emerging Themes from our research

Our aim with the current phase of risk finance research is to better understand the situations in which charities and social enterprises need risk finance and the kinds of risk finance that would be appropriate in different situations.

We talked to 20 charities and social enterprises, working in a wide range of different sectors and locations to find out more about their business models and how different types of social investment might help them to develop their businesses.

These interviews do not provide qualitative data – they provide snapshots of how some organisations think about social investment and what it could potentially do to help them.

Many of the organisations we talked to were in positions where they needed investment to get them to a point where they could prove their viability of their business:

“We are lacking that final bit of investment to finish off the product”

“Currently we buy from wholesale – but investment would allow us to begin to import own label products which we could hopefully get into retailers and therefore get higher volumes of sales”

“I do feel like I need some more funding to help jump-start and advertise my business before I can be independently self-funded”

“There are probably a lot of grant applications or government contracts that we could have gone for. We don’t have enough cash flow to take on the staff needed to pursue these opportunities.”

However, for some, conventional loan finance was either unappealing or unlikely to be available:

“We try and keep the fixed costs down. At the moment a loan is quite off putting.”

“We usually wait and build up enough money so that we can purchase it outright. Because I have been a limited company by guarantee, I can’t even get a credit card.”

“It’s a question of whether [we] could get a conventional loan. If you haven’t got the track record you won’t get it.”

For many interviewees, there were clear advantages to models of social investment aligned to organisations’ ability to pay:

“To some extent it would be more accepted to the trustees, who are not necessarily financially aware. Something straight forward like that could be good as they could directly see the relationship between performance and paying it back. A loan is seen as a lead weight around the neck.”

“If you have got a slightly more patient investor who says they don’t mind if you don’t pay a certain amount in the first year but allow [the business] to get on its own two feet. They won’t be breathing down my neck, then it doesn’t become a distraction, [thinking] about whether I must pay off my investment, so I can think about my social outcomes, which is why I have gone into this. This will work a lot better.” 

“Paying back investment based on turnover seems like a good idea… Anything like that which enables you to grow quickly but without having the looming pressure of repayments in terms of cash flow in terms of repayments is interesting.”

Potential uses of risk finance

Conventional loan finance is working well for many charities and social enterprise but for those operating in situations of uncertainty need alternative approaches.

The final stage of our research is to consider the models of risk finance that might be appropriate to different situations faced by charities and social enterprises.

Alongside the broad risk to the investor (of losing their money) some of the risks to charity and social enterprises that risk finance might address include:

  1. We are unable to get our product or service to market
  2. We will not have the capacity to deliver a contract we have been offered
  3. We will not be able to provide a service for the amount that the customer will pay us for it
  4. We will not be able to sell enough of our products/services to develop a viable business
  5. We are not able to increase our capacity quickly enough to cope with demand

The kind of finance needed to tackle this risk may take a range of forms from new approaches to grant funding to grant funding, to new funds, to new ways of supporting social investment by individuals. The final blog in this series will outline some of these ideas and suggest ways they could be supported.


Image credit: Paul Cross