Why Australian Social Enterprise Needs More Than Impact Investment

Despite the buzz, developing an impact investment market is not the answer for the provision of capital for all social enterprises in Australia, writes Libby Ward-Christie, Head of Investment and Advisory at Social Traders.

Of late there has been a lot of enthusiasm for the development of an impact investment market in Australia. Social Traders is keen to highlight that impact investment – that generates social impact and financial return – is not synonymous with social enterprise.  Nor is developing an impact investment market the answer for the provision of capital for all social enterprises in Australia.

Our experience, over the last five years, in social enterprise development and investment, coupled with examination of the more developed market in the UK, sounds a warning to those who believe that impact investment capital alone is the answer for supporting social enterprises in Australia.

Australia’s nascent social enterprise market requires a carefully blended mix of capital and support if we are to see a full spectrum of social enterprises realising their potential in this country.

You can conceptualise the capital available for Australian social enterprises as a continuum: At one end we have donation/grant capital, mainly provided by philanthropy and government, and to a smaller degree crowdfunding, and at the other end, we have impact investment – money to deliver social good with the expectation of a financial return – and, a little further along the continuum, commercial finance.

Each end of the continuum has particular characteristics.

Donation/grant capital tends to be driven by social issues of interest to the grantor, often requires charitable status and is generally designed to fund the delivery of a program that creates social good, but not to build or operate a ‘business’ that is self-sustaining in its delivery of impact.  It assumes expertise in the grantee to deliver social good, so rarely provides support along with capital.

At the other end of the continuum, impact investment available for social enterprises in Australia is predominantly debt (there have been a some equity capital deals, but Not for Profit social enterprises are limited to debt capital), and at the moment is mostly available through the Federal Government initiated Social Enterprise Development and Investment Funds (SEDIFs), that make available around $40 million for impact investment in social enterprise.

Impact investment is not accessible to all social enterprises

The complexity of impact investing in a social enterprise with the confidence of a financial as well as social return, means that the transaction costs of impact investment are high, resulting in the need for deals to be large (preferably in excess of $500,000) to justify the effort and to manage the risk of default. There is also generally a requirement for security, and in instances of no security; the risk-adjusted interest rates are high.  Also, given the already high transaction costs, the cost of a deal does not afford the provision of ongoing support to investees, beyond a monitoring function.

Given the characteristics of each end of the social enterprise capital supply continuum, it’s easy to see that different types of social enterprise are more or less suited to each end: pilot social enterprises are clearly the realm of donation/grant capital, in which the funder is willing to tolerate a high degree of risk. Conversely, impact investment is an appropriate and important source of capital for some social enterprises, particularly those that are mature, looking for capital to scale proven capability through purchasing assets, have greater risk appetite, often with for-profit legal structures (in which risk offers personal reward for owners), have a track record of revenue generation and a relatively high degree of profitability.

Pilots and mature, highly profitable social enterprises do not represent the full spectrum of the social enterprise landscape in Australia. In the middle there is a financing gap.

In the UK, where the impact investment market is more developed than Australia, the recent launch of Access (a new charitable foundation) aims to address what has been coined the “financing gap”, by providing charities and smaller social enterprises with the finance and support they need.

Access attributes the financing gap to:

• the shortage of unsecured, lower value flexible finance for charities and social enterprises that are seeking finance to test their model, survive and grow

• the high costs for social lenders to deliver this type of finance, which restricts supply

• the lack of track record and often the perception of risk which prices the cost of finance out of reach for social enterprises and charities.

This gap is particularly experienced by early stage, smaller charities, community and voluntary social enterprises, as well as more established charities developing a new income stream. Access’ solution is small, flexible, and affordable capital that combines loans, grants and capacity building support.

Through our on-going capacity building work, we have noticed this gap emerging in the social enterprise landscape in Australia, having provided the type of blended loan and grant capital along with support that Access in the UK is now calling for since 2011.

Social Traders has invested $1.6 million directly in 12 social enterprises, providing them with a mix of patient, unsecured hybrid loans/grants – depending on their needs and business models.  Just as important as the financial investment has been the ongoing advice and support we have provided, to enable them to “learn while they do”.

As Access says, “This ‘gap’ represents lost opportunities for organisations to change more lives or deliver more services for individuals and communities.”

There are many social enterprises that are at earlier stages of development, have Not for Profit legal structures (with honorary board or committee members that are not able and/or prepared to offer guarantees as security on loans), are looking for capital to grow their social enterprise at a moderate scale, and/or have business models that are sustainable but cannot service large loans.

These social enterprises are viable and make a real difference to our community, or at the very least with the right capital and support have the potential to do so.  Yet they cannot access impact investment and often are seen as too ‘commercial’ to be attractive to philanthropy – they are in the gap.

Through Social Traders’ experience over the past five years we’ve identified three important lessons that address the social enterprise ‘financing gap’ in Australia:

Lesson 1: For social enterprises that are in the gap, there is a need for tailored capital that blends grant and debt that is patient and prepared to wear significant risk.

There are high potential, nascent social enterprises out there, but they are not necessarily able to carry all of their capital as debt. Access to capital for this group is further exacerbated by the fact that not-for-profit organisations cannot access equity capital, a standard form of development capital in the commercial world.

The best approach for these organisations is to structure financing that is a blend of grant and patient, unsecured debt.

The quantum and the relative proportion of loan to grant depends on the business model and social purpose of the social enterprise and the risk profile of the revenue model.

Similarly, 100% grant capital is not necessarily the best solution for these ‘mid-continuum’ social enterprises either.

As tempting as it might be to have non-repayable capital, all of the social enterprises in Social Traders’ portfolio, whose debt ranges from 15% to 100% of their total capital requirement, agree that the loan component makes them more focused, more rigorous and more accountable.

We are seeing Boards engaging more fully in the development of social enterprise where there is a repayment obligation; ‘spending’ a grant tends to be regarded as operational and therefore not the realm of the board.

Lesson 2: These social enterprises know a lot about impact but need support as well as money to realise their potential.

Any business is hard to get right, but when you add to the degree of difficulty by overlaying a social purpose it’s almost a given that it will take a bit of trial and error to get things humming.  Increasingly we see those coming to social enterprise with very strong social motivation but less experience in managing a business. As such, it is important that any capital provided to earlier-stage social enterprises comes with support to ensure it is deployed in the most effective way. This often means being the ‘bird on the shoulder’ as a social enterprise develops, asking critical questions and advising when needed.

This is particularly true for new, start-up social enterprises that need support to identify when is the right time to develop business infrastructure such as finance systems, HR policies, and customer management databases.

For existing community sector service organisations that are moving into or operating social enterprise, many need help with techniques to forecast revenue reliably and regularly.

Lesson 3: We need to grow the whole capital supply continuum for social enterprise and address the financing gap.

Finally, Social Traders’ experience providing $1.5 million in blended capital together with $800,000 of support has taught us that an expectation of high impact and a good financial return is not realistic for all social enterprises.

There are many smaller, charitable and not-for-profit social enterprises that will never be able to access large, secured loans.

Often, these social enterprises address some of our most intractable problems that the market would not otherwise be willing to address; they provide access to important services for those too poor, too remote or too few for it to be worth the market’s while and they support and employ people that others say are too difficult to employ. These things take time to grow, and along that journey they need both capital and support in forms that are currently in very short supply.

About the author: Libby Ward-Christie is Head of Investment and Advisory at Social Traders. Social Traders is advocating for the filling of the current finance and support gap in social enterprise and believes that that the development needs of social enterprise go beyond accessing impact investment. In partnership with other social investors, Social Traders wants to play an ongoing role to ‘close the gap’ in meeting the diverse and complex finance and support needs of social enterprise in Australia.