- GIIN: First, a conversation with Nick O’Donohoe, Big Society Capital Chief Executive Officer. To jump to the GIIN’s interview with Sir Ronald Cohen, click here.
- GIIN: Tell us how Big Society Capital (BSC) came to be.
- Nick O’Donohoe:
The genesis of this idea started over 10 years ago in 2000 when the UK government formed the Social Investment Task Force, chaired by Sir Ronald Cohen. The task force made a number of recommendations that included creating a social investment bank, as well as setting up Community Development Finance Institutions in the UK and providing tax relief for social investment.
In 2006-2007, it was recommended that unclaimed assets from dormant bank accounts, those that have effectively been forgotten for 15 or more years, capitalize the social investment bank proposed by the Social Investment Taskforce. And so, with recently passed legislation, banks now direct any unclaimed accounts into the “Reclaim Fund” which capitalizes what is now known as Big Society Capital. In addition to the “Reclaim Fund,” the government also persuaded the four main UK high street banks—Barclay, HSBC, Lloyds, and the Royal Bank of Scotland (RBS)—to contribute. Today, we have 400 million pounds from the Reclaim Fund and 200 million pounds committed from the big four banks to fund this institution.
It is important to note is that, although capital is directed to Big Society Capital by the government, we operate independent of government. We have a standard company structure, our own board with no government representation, and a trustee board with just one government representative.
- GIIN: What is BSC’s intended role in the UK impact investment market?
The role of Big Society Capital is to develop the social investment market in the UK. It is intended to do that by providing capital to Social Investment Financial Intermediaries (SIFIs), which are organizations that provide access to capital for social sector organizations. A social sector organization is any organization that exists wholly or mainly for social purposes.
- GIIN: Why does BSC invest only in intermediaries rather than directly into social service providers or charities?
If you look at commercial markets, sources and users of capital are connected by a vast array of intermediaries—banks, brokers, venture capital firms, investment management firms, etc. However, in the social impact investing sector, that intermediary level doesn’t really exist. An important part of our job is to build that. To achieve this, we’ll be funding a whole range of new social investment funds, working with large financial institutions to help them develop their own social investment funds, working to develop and invest in the social impact bond (SIB) market. We’re also helping to develop the infrastructure around social investing, for example we’ve invested in the Social Stock Exchange.
This decision to invest in intermediaries was also made because the government consulted broadly with the social sector. At that time, there was a strong sense that using government directed money to invest directly in social service providers alongside an embryonic sector of small intermediaries would distort the market. Rather, it would be better to set up a funding source that feeds into these growing intermediaries.
And, finally, we’d be a very different organization logistically if we were engaging directly with the U.K.’s 160,000 charities and 65,000 social enterprises—we’d have to be huge. It made more sense to create a lean wholesaler providing money to intermediaries, as that also allows for the additional benefit of developing an intermediary sector that includes, for example, more specialized intermediaries by region or by social issue.
- GIIN: How does BSC intend to interact with other social impact investors in the U.K.? Is it a goal to encourage other investors to consider social investment?
It is fundamental for us to interact with other social investors and encourage more mainstream investors to get involved. Our mandate is to bring in other social investors—we never invest alone and always leverage other capital. A key part of our role is to proselytize social investment, get mainstream investors into this market, and over time create products that retail investors can invest in.
- GIIN: How does BSC learn about opportunities to invest in SIFIs, and what criteria do you use to gauge potential investments?
There are two ways our transactions are originated. One is more reactive, in that we have a process for intermediaries to submit application forms which we then review and assess. That pipeline was really waiting for us to come into being. So some of what we’ve done is just working our way through that obvious pipeline.
We are also trying to be proactive by strategically figuring out where the capital needs is, and then calling for funds to meet the social demand. We’ve been working to identify gaps in the market, social issues we want to address, and then trying to find intermediaries who will set up specific funds to address those. For example, the social impact bond market is growing quite quickly here, we think there needs to be an investable fund vehicle that will invest in outcome securities, so we’ve found a manager and are cornerstoning that kind of fund.
- GIIN: What are the basic parameters of your investments—size, length of investment? And what types of financial returns do you expect?
The size of our investments will typically be between USD 3-10 million. The timeline will likely be at least ten years before we see returns. With regards to our financial returns, our mandate is to be self sufficient, meaning that the capital can’t erode over time and we’ve got to cover operating costs and write offs. To do this, we are looking to achieve returns in the low to mid-single digits. These rates are below what commercial, risk-adjusted investors would require for investments that embody this sort of risk, but we do not seek or expect to earn commercial risk adjusted returns. On the other hand, it is also important to note that we do not give any grants-- we expect to earn back every investment with some additional financial return.
- GIIN: Can you talk a bit more about the specific social outcomes you’re looking to target and, also, how BSC approaches social measurement?
There are a number of different outcome areas we’ve identified, including education, health, prison recidivism, social care, drug rehabilitation, youth employment. In addition to identifying outcome areas, it was also important for us to define what we mean by social enterprise. One way to define social enterprise would have been to limit to charities and what we call community interest companies, but some of the fund managers who approached us as a cornerstone investor wanted the ability to invest also in for-profit companies. So, we published a governance agreement that articulates how we uniquely define social organizations. Our governance agreement includes a requirement for a clear statement of social objective, and for at least 50 percent of any surplus profit to be reinvested in the mission. It’s an available definition for others to reference.
In terms of measurement, we ask three critical questions around every investment and we expect the supported intermediaries to know the answers to these questions for the investments they make. The questions we ask are:
• Who are the beneficiaries that the organization is trying to help?• What outcomes is the organization trying to achieve?• How is the organization going to measure whether they are successful in achieving those intended outcomes?
Since we also have the ability to bring together various market participants, we’ve been working with other stakeholders including New Philanthropy Capital, Social Return on Investment (SROI), and the GIIN’s IRIS initiative to coalesce around some specific indicators and an outcomes-based measurement system, as much as possible.
- GIIN: Social Impact Bonds have received a lot of attention recently. Can you discuss why the ‘pay for success’ model been appealing to BSC?
Social Impact Bonds (SIBs) provide an opportunity to invest directly in social outcomes since social outcomes drives the payment. From our perspective, that’s a very attractive way to innovate in delivering services to the needy by way of social organizations, but for charities to participate in the market they need to attract risk capital from someone else, and that’s where impact investors can play an important role. In general, ‘pay for success’ transactions are still difficult to implement, especially because they are so new, but on a high level, they are appealing.
- GIIN: You co-authored the 2010 impact investing report with the Rockefeller Foundation and the GIIN. What have you seen in the market since that publication?
It astonishes me how much momentum that report developed in the market. The GIIN is actually a great example of the progress that’s been made. Two or three years ago we didn’t have ImpactBase or more than 50 organizations participating in an Investors’ Council for large-scale active impact investors
Impact investing wasn’t necessarily new at the time of the report’s publication, but in the last three to four years the momentum has picked up enormously. I spoke at a philanthropy gathering recently and the dinner was hosted by the Aga Khan. I was struck when he commented that he thought impact investing was the most important development in finance in the last 50 years. The growing enthusiasm for this market is remarkable.
- GIIN: Additional perspective from Sir Ronald Cohen, Big Society Capital Board Chairman
- GIIN: What parallels from the early days of the venture capital market development can be applied to impact investing today?
- Sir Ronald Cohen:
The most significant parallel is the identical dependence on a combination of entrepreneurship, capital, and management skills. With venture capital, there evolved an industry that backed entrepreneurs through intermediaries that provided both capital and management support. In impact investing we are doing the same thing but this time with a social objective.
- GIIN: Building on the lessons from venture capital, what is most needed to ensure the success of impact investing?
The first important piece of market infrastructure that helped make venture capital successful was the establishment of investment vehicles. Venture capital funds were established by aspiring investment managers to raise money from investors who are obviously crucial in creating a market.
Secondly, the 1978 amendment to the ERISA legislation encouraged investment in these new funds and so gave a huge boost to the development of venture capital. This said that prudent investors should invest in venture capital and that corporate pension funds must provide an explanation if they do not do so. Impact investing needs an extension of the “prudent man” rule in order to encourage prudent institutional investors, such as trustees of charitable foundations, endowments, and pension funds, to consider it.
The third lesson from venture capital is that early successes helped influence attitudes to accept venture capital as an asset class. This encouraged an allocation from financial institutions of every kind—pension funds, insurance companies, endowment funds, and even charitable foundations. It is similarly important that social impact investment becomes recognized as an asset class, over the next decade or so.
The parallels between the development of venture capital and impact investment are likely to continue into the future. If we succeed, social innovation will develop around the world to help deal more efficiently with serious social issues such as drug rehabilitation, recidivism, homelessness, and drop-out rates from education.
- GIIN: Designating impact investment as a discreet asset class is a somewhat controversial point of view. Please tell us more about your conviction that this is important.
What goes with an asset class is a decision by institutional investors to allocate capital and specialist investment skills. In the earliest days of venture capital, it was extremely difficult for venture capitalists to persuade the public equities manager of a big pension fund to invest in a venture capital fund that was likely to be illiquid for five to ten years. It became much easier once they gave a member of their team responsibility for investing a specific allocation. Over time, these institutional teams developed expertise and created confidence that the sector would deliver results.
In the UK we are just beginning to see some investors allocate money to impact investing. As they do so, these thought leaders will help define the characteristics of impact investment, and the financial and social returns it’s capable of achieving. If the results seem attractive, then these investors will increase the expert resources within their organizations and allocate additional capital to impact investing.
- GIIN: Are any infrastructure components unique to impact investing needed to establish this field?
There is a need to blend financial return, social return, and tax incentives, in order to develop the market. Development will, therefore, come a lot faster with the support of a social investment “bank” similar to Big Society Capital. I anticipate that many countries will see the establishment of a social investment “bank,” perhaps even following Big Society Capital’s precedent of accessing dormant assets to create a significant capital base.
So far, we have been talking about the funding of not-for-profits. Another unique challenge comes from the need to permanently embed social mission into the constitution of ‘profit with purpose’ companies. I believe we need to do this now. The corporate form may simply be the limited company of today, with a golden share whose vote is required to change its social objects in order to prevent drift from the social mission. If this golden share was held by a reputable charitable foundation or reputable trustees it would ensure that, if a ‘profit with purpose’ company is sold, it is sold with the social mission embedded.
Since, in the initial years, government will tend to be the principal commissioner of impact investment securities such as social impact bonds, government needs to make capital available for municipalities and states to supplement their own financial resources when they come to pay for results achieved. In the UK, the government has just announced an “outcomes fund” which gives local authorities the opportunity to tap into an initial pool of GBP 20 million pounds. This too is an important part of the necessary infrastructure.
- GIIN: The impact investing market, like all markets, is an interplay of supply and demand. Following the model of venture capital, your vision for growth focuses on fostering a healthy supply of investment capital. Please discuss the need to support investment-ready social enterprises.
This is an issue of the chicken and the egg: the two must come at the same time. We need to work on increasing the flow of capital into the sector and, concurrently, to deploy management skills to help social sector organizations scale.
Identifying and attracting social entrepreneurs capable of delivering social performance is the key, and it will be a challenge. However, even in the few months Big Society Capital has been around, Nick and I have seen increasing evidence of talented social entrepreneurs who are keen to make significant impact. In the younger generations of today, there are numerous gifted individuals who are motivated by the desire not just to do well, but to do good—so I think this is an idea whose time has come, and that we’re tapping into a deep pool of talented, socially-minded entrepreneurs.
There is huge latent demand for impact investment capital. Lack of funding is prevalent in the social sector everywhere across the world. If money isn’t perceived to be available, the challenge of raising capital appears so great that skilled, successful people do not take the risk of launching themselves into a social venture. If money is perceived as being readily available, people take the risk of launching out. In this sense, increasing the supply of money will create its own demand.
The key in developing a successful impact investment sector is to increase the amount of money flowing to appropriate financial intermediaries. They can then build teams that are knowledgeable about social issues. These teams will look for the right social entrepreneurs and enterprises to back. Successful venture capital firms are value-add investors who proactively engage with entrepreneurs capable of achieving great things. Through entrepreneurship and innovation venture capital has moved the needle on technology and economic growth. In a similar way, through social entrepreneurship and innovation, impact investment will move the needle on helping to resolve social issues and improve people’s lives.
A note to readers from the GIIN:
Diversity is a hallmark of the impact investment market, which has attracted traditional financial institutions, pension funds, private foundations, government-funded development finance institutions, fund managers, high-net-worth individuals, and family offices. As a nonprofit organization dedicated to increasing the scale and effectiveness of impact investing, the GIIN aims to bring transparency to this market and to the practice of impact investing. To this end, we believe it is in the interest of the field to share a sample of the diverse viewpoints held by investors who are motivated by social and environmental considerations. The publication of such diverse viewpoints, however, should not be construed as an endorsement by the GIIN of those viewpoints or the individuals or institutions expressing them.