Financing Social Enterprise: The Role of Builder Capital
The provision of services to meet social need currently has two key drivers in the UK:
- The need to cut the cost of providing services within existing public sector funded markets.
- The need to innovate to find new ways of meeting need in markets that have changed significantly in recent years
These drivers demand very different approaches to allocating capital appropriately and hence different funding models.
The first requires higher returns from the same or less investment, in other words, to improve capital efficiency. This might be achieved via scale economies, back office efficiencies or consolidation of fragmented markets. Examples would be the outsourcing of many public services via major managed services or facilities management operators such as Serco, G4S, Care UK, Veolia, Mitie, and Sodexo.
The second requires the creation of new economic and social value through the development of alternative models and different ways of tackling the problem.
In an ideal world some of the savings achieved from 1 would be reinvested in 2 but given the need to reduce public sector deficits at both national and local level the reality is that is unlikely to happen. Also, the funding models required to support 2 are very different from those required to deliver 1 and are likely to be provided by a different set of investors with different motivations.
In his article, “A Capitalist’s Dilemma”[1], Clayton Christensen distinguished between efficiency innovations which release capital from and reduce the number of jobs in an economy, and empowering innovations which create new jobs and additional sources of economic value. He goes on to explain why financial markets and methodologies which evolved during a period when capital was scarce are not well equipped to deliver the new growth needed in a time of quantitative easing, close to zero interest rates, and capital abundance.
In our paper “Financing Social Enterprise: The Role of Builder Capital in Funding Innovation to Address Social Need”, Robbie Davison and I argue that society needs empowering innovation - new, more effective ways of solving social problems and creating real, sustainable jobs. It is clear that we also need to find new ways of paying for such innovation.
Social enterprises are an important part of the ecosystem that solves social problems and meets social need. They will also be a key source of empowering innovation if they can obtain appropriate sources of funding. The UK is at the forefront of developing a social finance market in order to increase and improve the funding options available to social enterprise. Unfortunately, despite useful progress, there remains a wide gap between the supply of social finance and the demand for appropriate funding from social ventures.
Our paper argues that the main reason such a gap exists is that what the social finance market currently provides is “impatient finance” - either through debt products which require an immediate repayment schedule as soon as funds are made available, and often over a relatively short period of time; or, through equity offered by providers who are seeking to make capital gains and who therefore require high growth investees and a realistic opportunity to exit their investments within 5-10 years.
However, looking at financing needs from the perspective of the social enterprise, what is actually required in order to fund empowering innovation is risk capital that is sufficiently patient that it will support and develop financially sustainable enterprises, even in very challenging market conditions.
We call this “builder capital”.
Such capital is needed to:
- Pay for the establishment of the organisation
- Fund R&D to develop services / products
- Absorb losses while a viable business model is established
To continue the construction industry terminology, builder capital can be considered to be the financial scaffolding which supports formation of a financially sustainable organisation during its early phases of development.
It needs to be “ultra-patient” capital. Conducting R&D and establishing a viable organisation takes time in any field. It can be especially difficult for those trying to innovate in the solution of social problems. Commercial companies would normally fund R&D from profits, retained earnings or reserves. Social enterprises are much more limited in the funding options available to them.
Key features of builder capital are:
- Investors start by asking “is there an innovative market-based solution to this social problem?”
- And then “can the social enterprise providing the solution achieve sustainability if supported in the right way and with appropriate funding?”
- Builder capital is ultra-patient with no predetermined repayment schedules
- Capital is at risk
- Builder capital will deliver social returns only while the social enterprise achieves pre-agreed measures of sustainability
- Builder capital will deliver modest financial returns which are directly related to the success of the enterprise only when sustainability is achieved.
- Definitions of how financial returns are to be delivered (share of revenues, financial surplus etc.) and applicable thresholds will be agreed in advance and built in to contracts that will be binding on all parties as soon as builder capital is provided to the enterprise
- No ownership stake in the enterprise is required although an equity stake could be negotiated if that is the best way of meeting the needs of both the social enterprise and investor, provided that governance structure allows equity
Much work is yet to be done to determine if anyone is prepared to invest on the terms described here for builder capital. Such capital does not fit easily within the conventional risk / return spectrum because it is very high risk and yet offers no security or ownership stake in the enterprise. However, social investors, by definition, are not purely motivated by financial risk and return alone. If the term “social investor” is to have any real meaning there must be a way of incorporating social returns into the risk / return mix.
Initially, at least, we believe builder capital will be provided by private individuals, rather than funds or institutional investors. Providing builder capital to community-based social enterprises will especially appeal to individuals who have a particular affinity with a local area or who are personally affected in some way by the social issue being addressed.
For social enterprises that are truly innovative, in the Christensen empowering innovation sense of the word, social returns will be high and will be achievable from a very early stage – even during pilot / R&D phases. So builder capital investment should be attractive to those with strong social motivations and who are interested in supporting empowering innovation in order to meet social need more effectively.
The ongoing development of the social investment market in the UK presents an opportunity to take heed of what has gone wrong in “conventional” finance and resolve to learn, and apply, the lessons. In particular, we should ensure adequate capital allocations for the innovations that will create future growth and deliver improvements in social outcomes, rather than focus solely on the efficient use of capital.
By acknowledging the limitations of our current system, applying a clear-eyed approach to understanding what is required, and mobilising the resources of those who have benefited from a system which, it is now clear, is not designed to meet the most pressing needs of society, we can devise a new and more effective system of allocating appropriate capital to the enterprises that are able to use it in the best way for society as a whole.
Success in devising new ways of providing ultra-patient risk capital to early-stage, community-based, innovative social enterprises will be a significant step forward in meeting the needs of society, and in enabling those who have accumulated wealth to use it in a socially useful way. We believe that concepts such as builder capital bring true meaning to the words “social investment” and will ensure that the development of the social investment market will bring much needed resources to those enterprises which are best placed to meet social need.
The full paper “Financing Social Enterprise: The Role of Builder Capital" is available here
We are currently researching the market for builder capital and we are interested in speaking with potential providers and users of it. Please contact us for more information at:
Helen Heap This email address is being protected from spambots. You need JavaScript enabled to view it.
Robbie Davison This email address is being protected from spambots. You need JavaScript enabled to view it.
[1] “A Capitalist’s Dilemma, Whoever Wins on Tuesday”. Clayton M.Christensen. New York Times. November 3,2012: www.nytimes.com/2012/11/04/business/a-capitalists-dilemma-whoever-becomes-president.html?pagewanted=all&_r=0