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What Governments Can Do - Investment Vehicles and Financing Products for Social Impact

In an earlier blog we provided reasons for why government should support the development of impact entrepreneurship and social innovation.We also provided a framework for government action and introduced a number of tools (here). One of the most important government tools for stimulation of supply of financing and investment for social impact is the creation of investment and financing vehicles for social impact.

Impact entrepreneurs need financing as working capital to help with cash flow management; as development capital to grow and expand; and as reserve to protect against uncertainty. Most impact entrepreneurs in Turkey (and in other countries around the world), however, consider lack of finance their single major constraint for growing the organisation (Social and green enterprise survey Turkey (2013)) As hybrid organisations and pioneers in immature social investment markets such as Turkey they face challenges not only to find technical support to launch or scale their idea but also to find the right kind of finance and investment to meet their specific needs. In a previous blog we described that typical ‘chicken-and-egg’ problem in the social investment market in Turkey: Potential social investors – if they are aware of the opportunities – justify their reluctance to engage in social investment with the lack of “investment ready” organisations. Intermediaries argue with low transaction volumes that without philanthropic support or public subsidies do not allow them to offer financially sustainable services. As a result, social pioneers are unable to grow their ideas due to lack of suitable funding and support. Which again makes the emergence of investors and intermediaries less and less likely. And so on….

Some governments in other countries have therefore sought to break out of this cycle by supplying capital for social impact to support the creation of social finance intermediaries, attract private investors and to help build sustainable market infrastructure. As Sir Ronald Cohen, the ‘father of social investment’ in the UK argued in a 2013 Harvard Business Review blog on why social impact investing will be the new venture capital:

“It is true that in the case of social investment as it has proved to be true in the case of venture capital and private equity that the supply of money creates its own demand and an increased flow of capital is therefore the starting point.”

In recent years the field witnessed the creation of government initiated and (co-) financed investment vehicles to invest in social impact organisations or as fund of funds, in social investment funds (more details in the attached document):

  • Big Society Capital (UK/2012)
  • KfW Social Entrepreneurship Fund (Germany/2012)
  • EIB Social Impact Accelerator (EU/2013)
  • Social Enterprise Development and Investment Funds (Australia/2012)
  • Ghana Venture Capital Trust Fund  (Ghana/2004)
  • Inclusive Innovation Fund (India/set up phase)
  • Trividend (Belgium/2013)
  • DFID Impact Fund (UK/2013)

While interventions differ significantly across geographies and between investment vehicles, there are some interesting common features and trends:

  • Variety of financing instruments: Government finance is not limited to grant finance but increasingly involves a mix of financial instruments including guarantees, debt and equity finance.
  • Focus on measurable social impact: While financial returns on government contributions can range to zero returns to moderate returns or even market returns, investment strategies always emphasize the need for investees to demonstrate measurable social impact.
  • Role as catalyst: Government funding often is designed to play a catalyst role for attracting additional capital from the other market participants rather than Governments acting as the sole provider of finance. Layered financing structures in which governments assumes more risk and accepts lower or no returns compared to other more commercially oriented co-investors have become more common. In many investment vehicles governments match the investment size and amount with that of their co-investors. Co-investors typically include a variety of institutions ranging from foundations, development financing institutions, value banks to mainstream commercial financial institutions.
  • Independence and professionalism of fund managers: Government initiated and funded investment vehicles are in most cases managed by independent fund managers and investment professionals and set up at arm-length from government to prevent undue interference.

Most governments would argue that they simply lacked the capital required to kick-start the new industry and create a multi-million investment fund. One of the most compelling examples of how the lack of public funding may be addressed is the decision by the UK Government to use unclaimed assets from dormant accounts in banks and building societies to establish the wholesale bank, Big Society Capital in 2012.

Furthermore, governments and development financing institutions have issued bonds to raise finance for mostly environmental and climate change projects including. This includes the World Bank Climate Bonds, IFC Green Bonds or the Sustainability Bonds by three French Municipalities in 2012 (see Climate Bonds: the State of the Market 2013).

Social Impact Bonds as pioneered in the UK and currently adapted in various countries around the world raise finance from (social) investors for social interventions based on public sector savings achieved by superior outcomes of social support programs implemented by experienced social organisations and impact entrepreneurs (more on public procurement policies on one of our upcoming blogs). Finally, governments of countries as diverse as Israel, India, Nepal, Ethiopia and Greece reached out to their diaspora community to raise finance for development projects (see our previous blog on diaspora investing).