Market virtues and market vices

Rowena Young

Is the creation of better functioning social capital markets set to be one of the big stories of social change in the coming decades? Or is it just the over-hyped hobby of a few newcomers to the field, mainly with backgrounds in financial services, who have yet to understand the complexities involved in financing social projects, and whose grand visions will end up with little more than a few loan funds for income-generating social enterprises?

This edition of Alliance takes forward debates from the 2006 Skoll World Forum on Social Entrepreneurship, scoping out the ways we can most constructively think about capital markets for social ventures, and describing some of the most promising approaches that already show what can be done.

The fact that social capital markets have come on to the agenda now can be attributed to changes both on the demand side and on the supply side.

Changes on the demand side

Let’s start with demand. Social enterprises depend on increasingly diverse sources of money: philanthropic donations, funds from public agencies, trading income, and the occasional loan from a bank. But their sources are often unreliable, and the steady diversification has increasingly shown up the limitations of existing sources of finance.

Social entrepreneurs and NGOs today have moved far beyond the more traditional domains of agriculture, health and education. They run banking services (K-Rep in Kenya), news services (Oh My News in Korea), retailing and market access programmes (People Tree fashion in Japan and the UK, and numerous other trade justice organizations), public finance systems (Centre for Participatory Budgeting), transport (Riders for Health) and high-growth businesses (CelTel International). They produce pharmaceuticals (Institute for One World Health), run cities (Jamie Lerner, the Mayor of Curitiba in Brazil, is setting the gold standard with a carless transport system and innovations in education, housing for poor people, waste and health) and carry out conflict prevention (International Crisis Group).

All these activities depend on very diverse kinds of capital. Recoverable grants, soft loans, market-rate loans, loan guarantees and equity-like investments are likely to be as important as ordinary grants.[1]

There is also a collective benefit to the social sector in building access to higher levels of appropriate finance. As the number of social sector organizations grows, so too does the opportunity cost of funding these newer models from grant finance. If we can improve the mix of funding sources, we can do better at channelling grants to those NGOs that really need them.

Changes on the supply side

This demand for a wider pool of finance has coincided with greater willingness to supply investment for social purposes. This willingness has three main sources:

  • philanthropists and foundations wanting to use money in more strategic ways, with more of a mix of investment and grants so that money can go further;
  • financial institutions on the look-out for new outlets with better patterns of risk and reward, and slowly recognizing that social enterprises are often less risky than commercial investments (even if they also generally offer lower rewards);
  • governments offering new incentives and encouragements, like the community investment tax credits in the US and UK.

The ability to grow

The promise of this combination of enhanced supply and more sophisticated demand is that it will help more enterprises to grow, and thus to have a bigger impact. At the moment one of the ironies of the social sector is that there is little correlation between effectiveness and scale. Because of the lack of market incentives to reward social returns and the lack of any standardized measures of social returns, together with internal factors such as overdependence on founders or governance arrangements that are ill-suited to growth), many initiatives remain small or still-born however well conceived they are, and whatever their potential for replication.[2]

Some social enterprises do manage to grow, trading successfully in competition with for-profit companies, finding niches that have been ignored by mainstream business or tapping into public contracts or grant funding because their goals coincide with those of governments or donor agencies like the World Bank. A handful strike it lucky, gaining long-term support from foundations, perhaps gaining an asset which can be managed to provide sustainable income.

Some of the most famous social enterprises, like Grameen Bank, have managed all of these. Yet most fail to tap into these sources of growth and most feel that they have to run just to sustain their current scale of operation.

Changes in attitudes needed
Not surprisingly, few practitioners in the social sector understand much about corporate finance, and few have structured their organizations to make it easier to absorb capital from a range of sources. As Victoria Hornby of the Sainsbury Family Charitable Trusts observed at the Skoll World Forum, few even employ finance officers or advisers who can help them become investment-ready. Moreover, many are suspicious of anything other than grants, since accepting investment inevitably means accepting a new set of strings and constraints that inevitably accompany grant funding.

New providers of finance that combine financial and social return, and additionally help practitioners think through how they can use different types of finance to scale up their activities, are beginning to change attitudes. At the moment the value of the small number of providers of alternative finance (members of the European Venture Philanthropy Association, Acumen Fund, Futurebuilders and others) lies as much in the ways they enable practitioners to change as in the value of the money they disperse. This shift in attitudes is also being influenced by steady improvements in the range, quality, transparency and comparability of performance information.

New intermediaries
The foundations for more developed markets that can link the needs of thousands of social enterprises with the pools of finance that exist in foundations and financial institutions and among wealthy individuals are thus being laid. Indeed, the best sign that a new market is taking shape is the growing importance of a new breed of intermediaries, the worker bees that connect the different parts of the system.

Like Acumen Fund, they may use charitable grants from northern foundations to lever mainstream capital in emerging economies. Venturesome is using underwriting to enable mainstream providers such as retail banks to extend debt to enterprising charities and social enterprises, while GEXSI is researching a similar role in mitigating risk sufficiently for the private sector to invest in overseas development (see p53). Boutique brokers such as Blue Orchard are helping microfinance providers grow their sector by repackaging social enterprise and small and medium enterprise loans into portfolios that can be invested in.

Some in the social sector will worry that a proliferation of intermediaries will raise overheads, but, as commentators such as The Economist’s Matthew Bishop have argued, they are critical to achieving the efficiencies of a better functioning system. All mature capital markets have such specialists.

Yet the truth is that all this is still at a very early stage – whether we are talking of the venture philanthropy, community development and microfinance movements; the designers of new metrics and brokers of information such as GuideStar and New Philanthropy Capital; or the work of international agencies such as CDC (Capital for Development) and Aureos Capital, which are effectively serving as venture capitalists in places like Africa. All of these organizations are acting as pioneers – with the risks as well as the excitement that brings.

The big question is where this is all heading. Some of the evangelists of social capital markets forecast a rapid growth of secondary markets, new products, and funds offering various mixes of financial returns and social impact. Sir Ronald Cohen, chair of the UK Social Investment Taskforce, for example, already sees the need for a new wholesaler for the community development sector though it is only a few years old in the UK (and he may have persuaded the UK Government that this would be a good use for the billions of pounds left unclaimed in personal bank accounts).

What will all this achieve?

The optimists promise that such markets could help to solve several problems at once. For the philanthropic world, they promise a more results-oriented approach that may reinforce the current wave of philanthropic giving that has come at the tail end of the long boom that the West has been through over the last 15 years. Richer and more sophisticated information could be made available and adapted both for relatively time-rich professionals and for the time-poor wealthy. A full continuum of different types of investment vehicle could become normal – from full grants through repayable grants and below-market return models to full commercial investment.

For the recipients of funding, they offer the prospect of a more transparent and tailored relationship based on milestones for performance rather than capricious priorities and conditions. This is where equity funding is so important: it gives organizations the freedom to grow on their own terms and without undue risk (because investors don’t receive any money back unless the enterprise is successful) as they enter new sectors or experiment with hybrid business models or take time to grow.

Experiments with both institutional investors (including Blue Orchard’s MFI issue and some of the bond issues featured in this issue of Alliance) and individuals (Calvert Foundation’s Community Investment Note, Charity Bank in the UK, Shared Interest, and direct share issues at social enterprises such as Café Direct, Baywind and the Ethical Property Company) suggest there is no shortage of supply. For the right business models, there is in theory access to the right scale of growth capital on appropriate terms and with a sympathetic investor profile.

Another reason why social enterprises and NGOs should be interested in this field is time. It is commonly estimated that CEOs spend half their time raising funds – Rodrigo Baggio of CDI admits to spending 70 per cent of his time fundraising (see p38). With social investment, there is the potential to reduce this time commitment, particularly once the deals on offer and their reporting requirements become more standardized. Loans and equity finance are not right for all, but where the fit is good they can offer the freedom social entrepreneurs aspire to.

Doubts on the demand side …

What is striking, however, is the lack of enthusiasm from social ventures themselves, given that many social entrepreneurs and NGOs are clearly dissatisfied with the funding that is currently available to them. A recent survey by nfpSynergy in the UK, for example, reported that charities would trade in a restricted grant of £1 million for the freedom granted by less than £600,000 of unrestricted income. Most respondents were no doubt thinking of core funding grants, but the argument extends to loans and equity, where providers may place fewer conditions on the way their money is used.

Of course, investment brings with it other constraints. Generally, there are fewer if any constraints on how money is used but much tighter constraints on how much is paid out, either in repayments or in dividends. This is why so many small businesses have traditionally avoided equity – a few bad years can easily lead to a loss of control. But few institutions are truly independent anyway – the real question is what types of dependency are most appropriate.

… and on the supply side

These doubts are matched on the supply side. Some fear that for all the hype it will turn out that there aren’t all that many investment opportunities in the social sector, and that most funds will end up providing relatively low-risk loan funding for ventures in less innovative parts of the social sector such as housing. It certainly remains unclear whether there is the appetite for investing in truly radical and innovative projects. For higher-risk investors, incentives are lacking. Whereas in business the venture capital model allows a high level of risk because of the very high returns associated with intellectual property in a new drug or web venture, there is no equivalent prospect in the social sector.

It is equally unclear whether the more conservative investors will become involved in social ventures on any scale. In the US the regulatory requirements of the Community Reinvestment Act forced many banks into social investment – and many learned to their surprise that they could make profits in communities they had previously written off. But most financial institutions see this sector as at best marginal.

Attempts to change investor behaviour

This is why some of the bolder attempts to change behaviour are so interesting. Generation Investment Management, represented at the Skoll World Forum, is illustrative of this approach. Led by the powerful partnership of Goldman Sachs’ former CEO David Blood and former US Vice President and environmental champion Al Gore, Generation attempts to show how you can achieve better returns than from the mainstream market if you look beyond the short-termism of quarterly reports to analyse the influence of drivers such as changing demographics, population movements, climate change and changing public attitudes on corporate success. Their aim is to ‘green’ the public equities market, which dwarfs all others, so that it better reflects the real time horizons of a world with an ageing population and chronic challenges like climate change.

Even if they are successful, it remains unclear how much this will affect the social sector. Generation’s primary targets include the more progressive car manufacturers and energy giants, not hospices or projects for the homeless. But they are at least trying to expand the horizons of the notoriously narrow-minded financial world, and their work does throw down a strong challenge to charitable foundations and wealth managers who invest their assets – typically 95 per cent of their wealth – with no regard for their social impact. The standard defence, reinforced by habit and tradition, is that they are required to maximize financial returns, but in fact they are required by law to invest wisely in support of their mission and many could if they wished choose to run down their assets (see article on p54 where investment advisers discuss these issues).

Pioneers such as the F B Heron Foundation in the US have demonstrated the potential for using very different investment criteria and far higher levels of ‘mission-related investments’ (MRIs). Heron currently invests 25 per cent of its assets in support of employment, enterprise, housing and stronger communities among the poor, and performs at around the halfway point for its class. A rough count suggests a further US$150 billion could be released for social purposes if all foundations did the same.

The way forward

Social capital markets are coming, though the landscape remains messy, incomplete and uncertain. If you cut your teeth on grassroots activism in the mines of Fife, the streets of Dhaka or the favelas of Rio, all this may well appear morally dubious as well as practically daunting.

Commentators such as John Goldstein at Medley Partners or Jennifer Moses at ARK may yet be right in warning that the ‘fuzzy’ space between philanthropy and mainstream finance may prove too complex (though complexity is something the social sector has never fought shy of). It is certainly true that the recipients need to be closely involved in designing innovations – which happens all too rarely, apart from occasional exceptions such as described by Sheela Patel of SPARC (see p43) or Jamie Hartzell at the Ethical Property Company, a keen advocate for social equity markets.

For everyone involved, the promise is of a richer ecology of finance, with many more networks linking providers of capital and the people engaged in social change, with more information, more deals, faster growth and greater impact – a web of exchange that might resemble the flight paths of bees in a dense, busy meadow, each of them cross-pollinating ideas between different sources. We live in a world that combines many unmet social needs and enormous wealth, mostly disconnected from each other. Any new approaches that can put that wealth to work to address compelling needs must be welcomed – even if we should expect failures as well as successes as new markets take shape.

1 Jed Emerson and Joshua Spitzer with Gary Mulhair (March 2006) Blended Value Investing World Economic Forum. See

2 See, for example, Social Silicon Valleys: A manifesto for social innovation (2006) Young Foundation. See

Guest editors for the Alliance special feature, Grants and beyond: growing social capital markets
Rowena Young is Director of the Skoll Centre for Social Entrepreneurship. Email
Tony Wainaina is a founder and managing partner of Origins Venture Capital Fund for Africa and a board member of K-Rep Bank. Email

The Skoll Centre for Social Entrepreneurship
The Skoll Centre is mapping the changing landscape of social capital markets and plans further research into equity markets and valuation. It also facilitates Finance4Change, an international forum for innovators in the use of capital for social change.

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