The rise of social entrepreneurship has resulted in an increasing number of businesses seeking to maximize both social and financial returns. Like traditional businesses, they need equity capital to grow and achieve their objectives. With an estimated 15,000 social enterprises in the UK, it is clear that many new start-ups will require equity finance as they evolve. How can equity capital best be directed to social purpose businesses? Are existing equity capital markets sufficient to meet their needs? If not, is an alternative market mechanism required?
These questions formed the basis of research carried out by New Economics Foundation (NEF), in conjunction with the Charities Aid Foundation (CAF) and a group of stakeholders including Henderson Global Investors, GEXSI and Triodos Bank, to capture the views of key representatives from the UK social investment sector. The purpose of the report was to look at the challenges that equity listing raises for social purpose businesses.
Why a social equity capital market?
The research indicates that traditional equity markets pose a challenge to many social purpose businesses because of their single-minded focus on profit maximization, short-term perspective, and speculative nature, which does not value social outcomes. Recent examples such as Body Shop, Ben & Jerry’s, and Green & Blacks suggest that social purpose businesses may be in danger of losing social mission once they enter mainstream financial markets or sell out to a large firm. As a result, some social purpose businesses have opted for an alternative public offering, avoiding traditional equity markets such as OFEX or AIM.
On the supply side, most socially responsibly investment (SRI) funds invest primarily in FTSE 350 companies and are limited in the extent to which they can invest in unlisted social purpose businesses. The bulk of institutional funds, representing a significant pool of capital, are thus not accessible to most social purpose businesses. Even foundations and charities in the UK (who have approximately £40 billion of assets under professional management) do not invest in this sector, even at the margin. Where investments are made, it is in the form of grants rather than as a valued asset held on the balance sheet. Existing matched market methods for trading in unlisted shares are relatively illiquid and lacking in transparency, limiting the participation of large-scale investors.
It is clear that a forum for the exchange of equity would bring benefits for the sector by tapping into new sources of capital, promoting awareness of social investments, and offering the possibility of an expanded range of social investment vehicles. A social equity capital market could also improve transparency, liquidity and corporate governance standards across a young and fragmented sector.
What are the views of the sector?
NEF’s research indicates that, in general, industry representatives, including social investors, social entrepreneurs and SRI fund managers and advisers, support the concept of an enhanced market mechanism to improve equity listing for social purpose businesses. However, there is much debate on what form this market mechanism should take and whether the sector is ready for it at this stage.
Investors – both fund managers and private individuals – would like to see more regular reporting and disclosure, as well as more liquidity in the secondary trading of social purpose shares. In their view, a social equity capital market could establish an independent means of regular valuation and clarify financial and social return expectations, as well as giving FSA (Financial Services Authority) regulated status.
The trustees of foundations, and their advisers and fund managers, need to consider where social investments sit as an asset class. Is it in the private equity part of the investment portfolio or in the public equities part or, as is currently the practice, in the place called ‘grants’?
On the demand side, social purpose businesses require some ability to protect ownership and maintain control to protect their social mission. They are seeking investors that are aligned with the social objectives of the organization and share a long-term perspective that prevents speculation purely for financial gain.
What issues does this raise?
There are clearly a number of practical issues relating to the development of a social equity capital market. Interviewees questioned how a common definition of social purpose businesses would be agreed, who would administer the market, how businesses would be accredited, and what form social auditing would take. Some consensus on these issues needs to be achieved before a working model can be created.
Further, the report has generated a debate on whether there is a critical mass of investment-ready social purpose businesses. Few enterprises have carried out an equity listing to date (Café Direct, Traidcraft and the Ethical Property Company are among those that have) and the cost and expertise required may be beyond most enterprises – who might find it difficult to identify suitable advisers. The study notes encouragingly that some companies that have their roots in the social enterprise sector, such as Freeplay Energy and Monckton Group (owner of Good Energy), have successfully used traditional capital markets to raise public equity. Could greater momentum be created by the development of a focused social equity capital market to meet specific needs of the sector?
As in the traditional market, there is a need for intermediary institutions to carry out due diligence and facilitate access to the market. At the same time, technical assistance may be required to encourage smaller social enterprises to approach the capital market. For a dynamic social equity capital market to be realized, the engagement of a range of institutions and individuals will be needed. These institutions will need to work together to address outstanding issues, the first priorities being to develop awareness of social investment and new methods to support social purpose businesses to raise equity capital.
1 The research will be published as Developing a social equity capital market, to be published by NEF and CAF this autumn.
Jessica Brown is Project Leader, Access to Finance, NEF. Email firstname.lastname@example.org
Mark Campanale is Head of SRI Business Development, Henderson Global Investors. Email email@example.com
Asset class A specific category of investments, such as stocks, bonds, cash, or property. Assets within the same class generally exhibit similar characteristics, behave similarly in the marketplace, and are subject to the same laws and regulations.
Equity capital Money raised by a business in exchange for a share of ownership in the company. Ownership is represented by owning shares of stock outright or having the right to convert other financial instruments into stock of that company. Private equity is finance provided in return for an equity stake in potentially high-growth unquoted (eg private) companies. Public equity is finance achieved by selling stock to investors through a public equity exchange (eg the stock market).
Liquidity The extent to which a stock can be readily bought or sold without causing a significant movement in the price. Investments in liquid markets such as the stock exchange are considered to be more desirable because buyers know they will be able to dispose of their purchase easily without the risk of being forced to sell at a lower price.
Matched market A facilitated forum whereby a broker connects would-be buyers with would-be sellers and organizes the mechanics of the share transaction.
Secondary trading The process of buying or reselling securities in the public market after their first issuance to original investors.
Social audit A process which enables organizations to assess and demonstrate their social and environmental benefits and limitations.
Social equity capital market A stock exchange to facilitate secondary trading in the public equity of social purpose businesses.
Social purpose business Business with a social mission that generates both financial and social returns.