Why are the finance options for social enterprise so limited?

Welcome to the first Sparking Passion blog. Check back regularly or to hear news and views from the sharp end of the match.

The Spark team includes champions of social enterprise, leading social entrepreneurs, specialist social enterprise consultants and financiers and people working on all sorts of interesting projects to prevent and tackle homelessness.

In the first Spark posting Eastside Consulting’s managing director Richard Litchfield considers a question that perplexes many social entrepreneurs:

Why are the finance options for social enterprise so limited?

Someone recently asked me why social investors don’t take risks and back innovative start-up social enterprises. Their fund raising experience had shown that venture capitalists were willing to provide capital for innovation, but those investing in the social economy weren’t.

There are two ways to answer this.

The first is to dispel a myth. The UK venture capital marketplace is not an easy place for the entrepreneur nor is it a crucible for innovation. In fact, the emerging social capital marketplace is much more willing to accept risk than private equity. Any entrepreneur that has been through a venture capital funding round will vouch for this. Industry benchmarks indicate that VCs invest in only one of every 100 businesses they see.

In the social economy, most commercial risk finance is available as debt rather than equity. Following government backing in 2000, a specialist group of funders have emerged called community development finance institutions and they invest where the high street banks don’t go.

Big Issue Invest, the investment arm of the Big Issue, and partner in Spark is a community development finance institute and lender of last resort. The firm arranges venture-style deals and lends against cash flows.

While these are innovations, social enterprises still do lack access to equity. This is partly due to the legal structures of social enterprises. Many enterprises do not have shares (ie equity) to offer investors; or they have an asset lock precluding any sale and therefore exit for an investor.

For a number of years practitioners have called for patient capital and equity-style products to be customised for social enterprise. The Bank of England talked about this back in 2004.

Financing_social_enterprise_report.pdf2004

Spark does just this offering £500,000 patient capital to invest in social enterprises in the homeless sector. Winners will be enterprises that can demonstrate a real return on this investment – both social and financial. This patient capital will also act as a platform and we anticipate that it will leverage in a further £500,000 of debt through specialists, such as Big Issue Invest.

This project is intended to be a ‘spark’ for social enterprise in the homeless sector. Will it also be a spark for a new type of finance in the social economy?